Don’t assume that they are playing the game with you.
If your business is a baseball game and you are the star player of your team, your lawyer is just the umpire.
In baseball, umpires are responsible with officiating the game, including beginning and ending the game, enforcing the rules of the game and the grounds, making judgment calls on plays, and handling the disciplinary actions. They don’t come to practise with you, they don’t need to be in the field playing the game, and worse still, you somewhat have to respect them (at least during the duration of game). So, what are the umpires good at? They have a good understanding of the rules.
In the same fashion, lawyers are not building your product with you. They don’t stay up till 1am to answer your customer complaints or to build your investors deck. They don’t understand your product or your customers as much as you. Even worse, most lawyers don’t understand how startups work.
Why? Cause they are trained (by university) to handle corporate clients, IP, trademark, making contracts and do the fillings. So what are lawyers good for? Lawyers will able to tell you if you can do something within the confines of the law and your existing contracts.
Earlier this year, I was consulting a startup who was raising their series B round with 2 VCs. It was the final stage of the negotiations and each of the investors asked for a board seat. So, it was decided that there will be 5 seats: 2 for the incoming investors, one for the previous investors from the A round and 2 more common seats for the founders.
We continued discussing more terms, while the startup’s lawyer who was present was taking notes. I had no problem with that as it’s always better to have someone who takes notes during a meeting.
Towards the end of the discussion, the lead investor said:
“Oh, before I forget, it’s our standard term to require the CEO to be one of the common seat in the board.”
The CEO heard it and said:
“Yeap, that’s fine as I will be one of the common seat anyway.”
The lawyer nodded at the statement by the CEO and the investor, and continued taking notes.
Alarms were going off in my head. I looked around the team and the CEO looked happy with the terms. I looked at the lawyer and he was still looking down at his notes.
What went wrong?
Now, lets look at the subtle difference between what the investors suggested and the initial board seat arrangement.
Setup A: 2 investors from Series B, One for the investors from Series A and 2 common seats taken by founder 1 and founder 2.
Setup B; 2 investors from Series B, One for the investors from Series A, one for the current CEO and one more for the founder 1.
Now, if we assume that the CEO is the other founder, then setup A is exactly same as setup B.
Say that after a year, the investors appoint a new CEO who has more experience to scale the startup. Now, that means that setup A sides the founders but setup B sides the investors as the CEO was appointed by the series B investors.
With just a small tweak to the terms, the investors have created an opportunity to gain control of the board. It’s important to remember that you have done one or two deals in your life with terms sheets, while the investors do more than that in a month. Hence, they know how to think several moves ahead of you.
Why didn’t the lawyer know about this?
I have two potential answers for this:
1. The lawyer did not have much experience when it comes to startups, hence, he was oblivious to what just happened.
2. Both the startup and the investors are not breaking any corporate law. Hence, no red flags.
Naturally, I said:
“I think we should just create a new seat for the CEO. Then, if we have a split decision, then the founder 1 will be able to make the final decision. I think it’s important to do this to avoid any problem if we hire an outside CEO later on.”
I remember clearly the look on the lawyers face. He just realised what he missed.
I gave him the look I normally give when I know someone fucked up, but it’s fine cause at least one of us are awake and aware of what’s happening.
Don’t assume your lawyers know how to run a business or how to negotiate your startup terms.
This is very wrong. Overtime, following your lawyers advice can put you out of business while you will still be paying your lawyer every month.
When I first started my own business, I made the stupid decision of paying my lawyer an expensive retainer as I was advised that it will be cheaper in the long run. When we had cashflow problems, we still had to pay the lawyer and even when we went out of business, we had to pay off the lawyers before we could close the company.
Worse, the lawyer felt as if he knows the business and had too much BS advice at every turn. Initially, I thought it’s important to know the legal perspective of any matter. This was another costly mistake.
The lawyer had no idea how startups are run or how we have to be nimble to launch our product fast. After a few months of the constant advice over drinks and dinner that we paid, I realised that it was just noise. Most of the things that I had to know about the legal implication of my decision, I was able to just google it or ask someone else (or advisors) who is also running a business.