The topic of standardized angel or venture financing documents is is an old topic, for sure. Most recently, Brad Feld weighed in on this issue back in March 2010 by valiantly offering to take on the task of drafting standardized financing documents, but following a post by his partner Jason Mendelson (along with probably millions of emails from the disparate groups wanting to help), Brad decided to set aside the idea. Others have weighed in on this issue – Wang and Andreessen Horowitz, TechStars, YCombinator, Founders Institute, Fred Wilson, and another, and another, and even Yokum Taku weighed in with a comparison. I am not sure how much another opinion adds to this discussion, but it’s a topic I still view worthy of debate as I think it will re-surface again and again in the future.
People in the start-up community have long called for a set of standard financing documents – a set of financing documents whose structure and substance were widely viewed as acceptable to both the entrepreneur as well as the financier (e.g., angel, super-angel, early stage venture fund) and that fulfilled each side’s legal/business needs. Why standardize financing documents versus any other corporate set of documents? Well, one of the greatest needs for a start-up or early stage technology company is the capital needed to fund growth. The lack of capital lies at the very heart of building an emerging growth company. Entrepreneurs also don’t have the patience for long drawn out procedures so early in a company’s existence. Speed is viewed as a competitive advantage to some. Given that lack of capital, as well as the quick need for it, both entrepreneurs and angel and venture financing groups have long wanted a standard set of financing documents that could quickly result in a closed financing round. A round of financing quickly closed on mutually acceptable terms and costing the least amount of money (i.e., legal fees) would be the goal. If both goals couldn’t be achieved, I think reduced fees would be favored over speed when it comes to standardized financing documents.
With that being said, if I had to argue against standardized financing documents, I’d probably point out the following flaws:
- Not all Deals are the Same – the earlier the financing round, the more homogeneous the terms, however, the later the round of financing the less likely standardized documents are going to work. If standardized financing documents were a reality, I think for this reason they would be limited to either angel or series seed deals. Growth rounds have more complexity built into them (e.g., recapping, taking out early investors, letting founders take money off the table, wash-outs or cram downs, etc.), and therefore may not lend themselves to a “canned” document.
- As Much as People Love to Knock Lawyers, Getting Deals Done is an Intelligent Process – as much as people like to knock lawyers, some of us love the start-up space and work very hard to provide real value to early stage companies. Many of you have probably witnessed first hand the value add from these types of lawyers being involved in these types of rounds. Create standardized documents and I can guarantee you lawyers of all walks (read: lawyers without the proper start-up or early stage financing experience) will start offering these types of services to early stage companies because of the comfort that “canned” documents give them. Just because you attend a CLE (continuing legal education) course on mergers and acquisitions, and walk with your book of forms, does not an M&A attorney make. Look at every venture blogs’ posts (including my own) and you’ll see advice about hiring the right lawyers early for this type of work. Start relying on “canned” documents and this problem will grow worse by a magnitude. The fact that most lawyers that do this work have learned the trade in the old apprentice fashion (having been taught by those that have done it for generations prior) is a barrier to entry. Remove that barrier and the goals of speed and saving money will produce leagues of early stage companies with inexperienced advisors.
- Do You Really Want to Feel Like You Just Bought a House When You Close Your Series AA Round? – look at the areas that do use standardized documents and look at the lack of leverage in those deals – buying a house, taking out a mortgage, leasing a car, renting an apartment. These form documents certainly save money for the person with the leverage (i.e., the person selling the house, offering the mortgage, leasing you the car or renting you the apartment), but they don’t create a level playing field. The person taking the product or service generally carries the risk that the form documents are adhesive. The old adage – he who has the gold makes the rules, applies here. I think over time, the standardized document might shift to the party with leverage.
- Attempts to Date Have Failed– other than the form documents that are used specifically inside a model (think TechStars, YCombinator, etc.), most form documents have not taken off. In particular I think of the NVCA form documents. The only time I hear or see them referenced in a deal is when one party is trying to convince the other that a particular provision is or is not industry. To the extent that provision is or is not in the NVCA form documents, I’ve seen parties reference that fact as proof that they are correct.
Leveraging off of the second bullet point above, I think my greatest argument against standardized documents requires one to think back to the industrial revolution. Prior to the industrial revolution, goods were made by craftsman. A trade taught to the young by those with more experience, and passed down over the years. Following the industrial revolution, mechanization (read: standardization) was the key to saving time and money. The industrial revolution killed the craftsman, much the way big box retailers killed the mom & pop store (for those of you that remember the days when customer service actually meant something). I think standardized financing documents will have the same effect. It will destroy the legitimate skill set that some of us possess in the start-up and early stage space. And it will rob the younger associates of the real skills required to represent great start-up and early stage companies in financing rounds.
My Solution: Okay, but come on – for those of us touting the fact that we are innovative start-up lawyers and providing value to these young companies, we cannot just end it there -right? If I am right, that saving money is at the heart of the problem, then there must be some way to reap the same savings but maintain the valuable process of drafting and negotiating financing transactions. I think the answer lies in how lawyers bill for this work. I think you can get to the same result of standardization if lawyers would just agree to cap the fees they charge. For those of us that possess the right experience for this work, most of the problems or hurdles we hit in closing financing rounds have been seen before and dealt with. I have yet to come across an issue in getting a round of financing done that isn’t somehow derivative of some other issue I’ve run into before, and therefore I probably already have some way of dealing with the issue. I see no reason lawyers cannot come up with flat fees for closing these rounds that solve the “expense” issue and still allow the deal to move quickly and close inside a time frame that any of us would consider reasonable.
Just my two cents. I welcome your comments and/or questions.
Chris McDemus is founder of VC Deal Lawyer, a blog devoted to providing insights on start-up and emerging growth companies. Chris is also founder and owner of MCD Law Partners, LLC, a boutique corporate law firm serving start-ups, early-stage and emerging growth and middle market companies.