In goodnews, goodcounsel’s highly occasional newsletter, I explained how early-stage companies that are set up as LLC’s can use “profits interests” instead of conventional options as a tax-advantaged way to offer employees incentive equity. There are some associated downsides and hassles, however. Read the article here.
Categorised as: Capital Structure, Startup Stuff
Take a look at the section below, from a contract a client gave me to review today. What is wrong with this picture?
Found it yet?
It’s at the end, where the words say “One Hundred Seventy Five Thousand Dollars” and the numerals say “$100,000.” Notice that this is not a small-change mistake. It potentially means a difference of $75,000 in liability for one of the parties.
Categorised as: Lawyering, Legal Drafting, News and Views
For those who do not receive goodnews by e-mail, you can view all editions online here. Of course, it’s just easier to become a subscriber.
Categorised as: goodcounsel news, Lawyering
I would like to use Facebook more. Without a doubt, there is great utility in a social platform that everyone is on, can be used as a universal identity for logging in or commenting on other sites, etc. But because of their customer-unfriendly privacy practices, I use it rarely and with great caution. I know there are a good many others like me, and I suspect our ranks may be growing.
I know they have no choice — in their current model, if they don’t convince me to share personal data with them and then convince (or trick) me into letting them share it with advertisers, they don’t make any money. But the key phrase here is “in their current model.” Was there a different road Facebook could have taken? I think so.
Categorised as: soapbox
After “should I form a corporation or a LLC?” this is probably the question I get asked most often. I thought I’d to try to offer a quick, simple overview, with a few links for those with an interest in the gory detail. Here goes. This is general information, not legal advice, capisce? (Duh.)
For the uninitiated, let me frame the issue: you want to raise capital for your startup. You can:
In my experience, convertible notes are more common. Why?
If you are dealing mostly with friends and family or other investors who are likely to work with you on the basis of trust, convertible notes will likely be acceptable. VC’s and sophisticated angel investors, on the other hand, look disfavorably upon convertible notes (e.g., Fred Wilson, Seth Levine). Their main arguments:
There is no single “right” answer here. As a purely practical matter, startups are extremely cash strapped, and the ability to do a small round for a few thousand dollars is awfully compelling. We all know that many startups raise seed money when they are still extremely immature businesses, and a good number won’t ultimately survive. It doesn’t make a lot of sense to spend more money and time on a small seed round under those circumstances.
However, I think there’s a lot to the argument that you want to be economically aligned with your angels. It motivates them to help as much as they can, plus, these are usually people you know well. You want them to fully share in your success.
My take is this: use a convertible note when you need to raise a small amount of money, inexpensively, to buy you a few months to prove the business concept and get quickly to the point where raising a larger round becomes feasible. When you raise a larger round a few months later, your convertible note investors will still get a reasonable valuation, their discount will fairly compensate them for a few months of greater risk, and you won’t mind spending a little more time and money to get it done.
As with all questions like this, I always tell people that it’s an important issue, but not one that should distract you for very long. You’ve got a business to create, and time is your most precious asset. Neither decision is wrong, so make the decision and move on.
——
I did not cover, above, the ways that convertible note rounds can be made more “equity-like.” The how’s and why’s of price caps are explained well by Brad Feld, among others. Price caps are okay, but then — as with a recent client experience — a smart founder will want a corresponding “floor.” (The price cap protects the investor on the upside, by placing a maximum valuation on the later conversion, and the floor protects the company/founder, by placing a minimum valuation on the later conversion.) Once you start going down this road, my view is that you start losing the advantages of the convertible note, and you might as well just go with a priced equity round.
UPDATE 9-14-12: For those interested in understanding these issues in horrific detail, I see that Mark Suster has a detailed post out on the subject (hat tip: Technori). Some interesting and quite valid perspectives there, and in the comments too. My take is that — outside, perhaps, very sophisticated VC’s negotiating with very sophisticated founders over very significant rounds — it’s just not worth the brain damage getting into it at this level. Maybe if you’re a VC who negotiates deals for a living…
Categorised as: Capital Structure, Frequently Asked Questions, Startup Stuff
I know it’s not front-page news that big law firms charge big fees. I should know; I worked at a couple of them. Still, I’ve been out of that world for a long time now, and one forgets.
So, without naming any names, here’s a story: A startup client of mine recently secured a significant equity investment from a major local private equity investor – a commitment in excess of $25 million. As is often the case, the investor dictated the lawyers that the company had to use. (Hint: it wasn’t me.)
The deal just closed, and I caught up with my client to get the lowdown. The legal fees on the deal were – wait for it – over $175,000. Read the rest of this entry »
Categorised as: Lawyering, Legal Costs
Playground fun or death trap?
Photo credit: Gabriel Pollard
I have young children, so I’ve been frequenting playgrounds over the last 8 years or so. I’ve noticed, during this time, that there’s an incredible degree of sameness to them. Something has homogenized our playgrounds. They are almost uniformly boring.
One example: I noticed that a staple of the playgrounds of my youth, the see-saw, is gone – gone, or replaced with a bastardized version with springs rather than a fulcrum, so that at rest, instead of one side being up and the other side down, it just sits there horizontally. The problem, of course, is that even when kids are using it, the springs prevent it from going up or down much on either side. What is the point of a seesaw that doesn’t go up and down? Lord have mercy. No wonder my kids have no interest in these.
I thought about it for about a half-second, and figured that personal injury lawyers must have something to do with this situation.
And indeed, it seems to be the case that after a spate of personal injury litigation in the 1970’s, municipalities started tearing up playgrounds, taking out equipment such as high jungle-gyms and fulcrum seesaws, and replacing them – if at all – with “safer” equipment. Safer, as in less challenging and less fun. (As an aside, I wonder if the problem in the 1970’s, when cities were going bankrupt, wasn’t so much with playground equipment per se, but rather, with poorly maintained equipment.)
I am sure that you can find some terrible stories of children getting hurt on playground equipment, but it’s hard for me to believe that they are a statistically significant source of childhood injuries. Checking the CDC website, one learns that in the decade 1990 to 2000 there were 147 playground deaths of children 14 and under. Each of those was a tragedy for a family. But looking at this scientifically, this amounts to just under 15 deaths per year. Some of these deaths, according to statistics, were due to inadequate supervision or other causes, not any inherent danger of the equipment. Now, look at the overall mortality rates for this age group. In just one year, 2008, 4,643 children age 14 years and under died from “unintentional injury.” Doing the division, this means that playground accidents accounted for three-tenths of one percent of the accidental fatalities. The leading causes were, in order: motor vehicle crashes, suffocation, drowning, and fires/burns. (So, if you really want to protect your child, live in a densely settled, walkable neighborhood that doesn’t require car trips for everything. Your family will be healthier in every way.)
Fortunately, it appears that the pendulum may be swinging back. (Swinging pendulums? Those are dangerous!) Experts in child play (what a great job that must be) have begun to appreciate the extent to which kids need challenges and, yes, just a little bit of danger in order overcome fears and master the real world — a world in which springs cannot be attached to everything to smooth out the highs and lows.
There’s a lesson to be learned that goes beyond playgrounds. People in general and lawyers in particular seem to think that all risk can be eliminated. Of course, it can’t be. A certain amount of risk is inherent in every human activity. By going overboard to stamp out risk – to prevent whatever small part of the 15 annual playground deaths that can be attributed to “dangerous” equipment – we have spent millions tearing up nice old playgrounds, and replacing them with bland, boring ones that don’t serve the intended developmental purposes. So, in which scenario lies the greater cost?
In business deals, the lawyer you want at your side is the one who tries to minimize risk but who also realizes that risks are unavoidable and, that by trying to avoid them completely, you run the larger risk of killing the deal entirely – losing out on potentially greater benefits.
Next time you are thinking about hiring a lawyer, ask where he or she stands on the issue of seesaws.
Categorised as: Lawyering
Among the benefits of leading a small legal practice is that it keeps all of the relationships close and manageable. I know my clients well, and I serve them directly (not via associates, paralegals or other intermediaries). Larger law firms are, well, larger. This means that there are dozens, if not hundreds, of people affiliated with one another under the firm’s banner, many of whom don’t know each other particularly well. That is advantageous in some ways — especially financially for those at the top of the hierarchy. On the other hand, the partners are all responsible for each other’s work, legally and — as my tale below illustrates — in other important if less formal ways.
I recently asked some of my colleagues to send me recommendations for a superstar lawyer with a specific capabilities. I was given the name of one fellow and looked him up. Turns out, he is at a national law firm with a Chicago office that I encountered when I was general counsel at HighBeam Research. A corporate lawyer from that firm (not the Chicago office) was on the opposite side of the transaction from us when we were selling the company, and was one of those lawyers who gives lawyers a really bad name — overly legalistic, completely impractical, and lacking in any social skills on top of it all. (She would have been a great Dickens villain.) The deal almost didn’t happen because of her style of lawyering. I still have a physical reaction when I think of this — and it took place almost 4 years ago.
The lawyer who was recommended to me is probably very talented, but given his partners are, I will probably look elsewhere.
Categorised as: Lawyering
Lousy photo of Adrian Holovaty (right), with Alfonso Ponticelli
At last month’s Northwestern Entrepreneurship Conference, Groupon CEO Andrew Mason was a featured speaker. Mason, as many now know, was a music major at Northwestern. Peter Barris of NEA (one of Groupon’s major investors), who shared the stage with Mason, noted that musical talent seemed prevalent (in his experience) in technology entrepreneurs.
This observation came to mind when I went to see another fine Chicago entrepreneur, Adrian Holovaty, at the Green Mill last Wednesday. Adrian, the founder of Everyblock (now part of MSNBC.com) as well as the co-creator of Django (“an open source web application framework for Python”), is an extraordinarily talented guitarist, and performs each Wednesday at the Green Mill as part of the Django Rheinhart-influenced guitar group Alfonso Ponticelli and Swing Gitan. (Hmm, wonder where he came up with the name for that programming language of his.)
If you haven’t been to the Green Mill, it’s one of the famous music venues in Chicago, a must-visit. So go on a Wednesday and see Adrian play. I can’t say how Adrian’s software code his, but the man can really play guitar.
Categorised as: Entrepreneurship
Lawyers, like everyone else working for a business, need to add value. I see so much legal work, however, that adds no value whatsoever. The economics term for it is “deadweight loss.” The client might as well just take out a few hundred-dollar bills and burn them.
This blog post is the first of what is sure to be a long series, shining light on things lawyers do, large and small, that are a complete waste of time.
Lawyers as a group too often ignore common sense, focus on form over substance, and fail to weigh the costs of an activity against its benefits. We have to get back to using good judgment, focusing on what’s really important, and abandoning the false idea that there is no risk too small to beat to death.
Categorised as: Lawyering, Legal Costs