Unlawerly

Launching Funding Community

Sun, 12 May 2013 22:00:00 -0400

This is just a quick post about some big news!

Last week we launched Funding Community to the world. This had to be one of the most nerve wracking moments of my life. I knew we were ready to go, but there were so many “what ifs”!

We launched Wednesday with only a few minor glitches and a lot of great feedback!

The reason I am so excited about Funding Community is that I really think what we are doing is incredibly meaningful and innovative. In some sense when I try to explain this to some people it feels like explaining to a non-art lover why a Kandinsky is so gorgeous and complex, not just something any five year old could could create. (Not that Funding Community is as brilliant as a Kandinsky, but the broader point holds I think…) Funding Community is the result of an enormous amount of legal and technical work pulled together to create something that has never been done before. A lot of people get it, but sometimes when talking about what we’re building I feel like just throwing up my hands and saying “it’s beautiful because I say it is!” I really hope people will check it out themselves and realize the simplicity of being able to make an interest bearing loan in support of a small business seeking capital to grow.**

I keep telling myself that the best ideas are always the ones that make people scratch their heads a bit. We are just getting started and have a lot to do, but I am incredibly optimistic!

Sign up, make a couple loans at https://www.fundingcommunity.com and let me know what you think at Alex[at]fundingcommunity.com!

** If you’re curious about why I say “loan in support of…” it’s because on Funding Community you make a loan to our company that allows us to make a corespondent loan to a small business. We do this for regulatory, logistical and default reduction reasons.

Grant your stock options - Seriously, grant them now!

Mon, 08 Apr 2013 12:44:00 -0400

I have this pet peeve that’s come up half a dozen times in the last year. As most readers of this blog know I don’t really practice these days (I still have my license so can do work from time to time, but don’t practice regularly), but I end up giving a lot of “free” advice (usually for a cup of coffee).

The issue that keeps coming up is the timing of stock option grants. Should be simple, right? A startup wants to hire you, they tell you they’re giving you 10,000 options “subject to approval by the Board of Directors” (which is very common language), and when the company sells or goes public you make millions. If only it were that easy…

Here’s the problem.

Because of the way the tax code is set up options have to be granted with an exercise price at or above their fair market value at the time of issuance. The issue is that the “time of issuance” is the date on which the Board approves the grant, NOT the date on which you are promised the options. This means that if you are promised the options in January when they are worth $1/share, but the Board doesn’t approve the options until September after a huge financing round, the options may be worth $5/share. You’ve just lost $4/share value on 10,000 shares. Not good.

Why might this happen?

Well, sometimes it’s a matter of just not wanting to deal with paperwork (never underestimate the brutality of paperwork). Sometimes it’s a matter of not having a real “valuation” of the company (in theory the company should have a valuation done prior to granting options, though in practice it’s not always necessary). That should never hold up a grant though, since a valuation can be done very cheaply. Most often, things just fail between the cracks.

So, what are your options?

The best option is that if your option grant is taking a while you shouldn’t be afraid to talk with your boss at the company to try to get it sorted out. Heck, show them this blog post and explain the issue. Maybe it will help.

If you’ve already been hurt by this situation you can certainly ask for more options to compensate you for all your lost value. The company is not going to want to do it, but again, if you show them this post maybe they will have some compassion for what they’ve done. This is their mistake, not yours.

As always, this isn’t legal or tax advice, but I hope this helps!

How I Learned to Stop Eating and Love the Fight

Thu, 24 Jan 2013 23:43:00 -0500

This post came about from a conversation I had with Jake Sattelmair, a former teammate and founder of Wellframe. You can find his version at jacobsattelmair.com.

8 tall skinny men stand near me. No one is talking. We haven’t eaten in the last 24 hours. No one has had more than a sip or two of water since we woke up this morning. One by one we step on a scale and an official calls out our weight. Alex’s turn. At 6’1” he clocks in at 154.5lbs. Right on target. Then it’s Jake’s turn. 6’4” and 159.9lbs. WHEW!

We’re not prisoners being starved. We’re not POWs off in some god forsaken country. No, we’re men of Harvard. So why are we doing this?! Well, we’re also lightweight rowers. This means 8 men working together in perfect synchrony. 8 men who can’t weigh more than 160lbs each and whose average weight can’t exceed 155lbs. We made it.

The next day, Saturday May 31, 2003, we woke up and put ourselves in more pain than we’d ever been in in our lives, me doing so with the cartilage between two ribs torn apart. We raced a 2,000m heat in 6:03, winning by just over 2 seconds. Later in the day we raced in the national championships final. 2,000m in 5:54, winning by just under two seconds!

So, was that just a blip in my life or was it a learning experience?

For the last 10 months I have been hammering away on a startup where there is no pay, no vacation and no teacher giving me gold stars. At the same time it’s awesome and challenging and freeing and something amazing I’m choosing to do. Startups are hard. We get it. Bloggers write about it all the time. You know what else is hard? Training twice a day for 10 years, being an outcast in a school that only nominally cares about the sport you love, giving up summers when most kids are going off to camp and you are going to a “camp” of a different, much more painful kind. You know what else is hard? Being 6’1” and weighing less than 160lbs and rowing with torn cartilage!

I’ve been in self-imposed pain before. I’m prepared. I didn’t always win, but I always put myself in the best position to do so.

SEC Acts on Title II of the JOBS Act

Thu, 30 Aug 2012 12:59:57 -0400

The SEC took a big step yesterday. Using the mandate set forth in the JOBS Act, for the first time since the promulgation of Rule 506, the SEC has taken a step towards allowing Rule 506 offerings that are conducted through a general solicitation. The SEC proposed an amendment to Rule 506 that would add a section 506(c) as follows:

“(c) Conditions to be met in offerings using general solicitation or general advertising.

(1) General conditions. To qualify for exemption under this section, sales must satisfy all the terms and conditions of §§ 230.501 and 230.502(a) and (d).

(2) Specific conditions.

(i) Nature of purchasers. All purchasers of securities sold in any offering under this § 230.506(c) are accredited investors.

(ii) Verification of accredited investor status. The issuer shall take reasonable steps to verify that purchasers of securities sold in any offering under this § 230.506(c) are accredited investors.”

This means that so long as all investors are accredited investors and the issuer has taken “reasonable steps” to verify that status, the issuer may raise money through a general solicitation and still fall under the Rule 506 exemption.

There is still a lot to chew on here. First of all, and this always bears repeating, this amendment is not yet in effect. It is just a proposed amendment, so don’t go out there buying adds in the Wall Street Journal just yet!

Second, section 506(c)(2)(ii) is obviously fairly vague. The issuer must take “reasonable steps to verify that the purchasers… are accredited investors.” The old “accredited investor” standard was that the issuer needed to have a reasonable belief that the investor was accredited. The venture community got comfortable with the notion that an “Accredited Investor Questionnaire” was sufficient for this purpose. But now issuers will have to take “reasonable steps to verify.” It’s a subtle difference, but a difference nonetheless.

In its rule proposal the SEC expressed that the question of whether an issuer has taken “reasonable steps to verify” and accredited investor’s status would be an “objective determination, based on the particular facts and circumstances of each transaction.” These facts and circumstances include:

the nature of the purchaser and the type of accredited investor that the purchaser claims to be;

the amount and type of information that the issuer has about the purchaser; and

the nature of the offering, such as the manner in which the purchaser was solicited to participate in the offering, and the terms of the offering, such as a minimum investment amount.

The SEC specifically told us that a mere accredited investor questionnaire would not be sufficient if you are attracting potential investors into a mass-audience online portal.

All in all this is probably less restrictive than most people thought, but also provides a little less guidance, so we are going to have to feel it out a bit and do our best to stay within the SEC’s boundaries until we have a little more clarity.

Rule 506 General Solicitation Prohibition Removal Delayed

Mon, 20 Aug 2012 13:17:00 -0400

This post is being cross-posted to FundedCommunity.

In all the brouhaha about the Crowdfunding exemption of the JOBS Act I think we often forget about one provision that is nearly as revolutionary: the removal of the general solicitation prohibition from Rule 506 of Reg D.

Let’s start with what Rule 506 is. First things first, in order to issue securities, those securities either need to be registered with the SEC or they need to be exempt from registration. Almost all startups try to avoid registration because it becomes very expensive and complicated. Rule 506 is one of the most popular exemptions from registration because it actually provides a safe harbor to companies issuing securities under it. This means that if you follow all the steps in Rule 506 the SEC cannot require you to register the securities and no investor can ask for his/her money back by claiming the “private placement” was invalid

A traditional 506 offering has the following basic requirements (along with a few others I won’t get into here):

No general solicitation or advertising to market the securities

Sales to an unlimited number of accredited investors and up to 35 unaccredited investors (who must be sophisticated and knowledgeable enough to evaluate the merits and risks of the investment)

The issuer must file a Form D with the SEC, which states the size of the offering, number of investors and a few other pieces of information (failing to file this is where a lot of companies blow the safe harbor. Brad Feld wrote an interesting piece about filing Form Ds here).

Title II of the JOBS Act requested that “not later than 90 days after” the enactment of the JOBS Act, the SEC revise Rule 506 to provide that the prohibition against general solicitation or advertising will not apply to offerings under Rule 506 so long as all investors are accredited investors. The revised rules will also need to require the issuer to take reasonable steps to verify that the purchasers of the securities are in fact accredited investors (right now an issuer need only have a reasonable belief that the investor is accredited – usually via an investor questionnaire).

This means that you will be able to shout from the rooftops (or take out an ad in the Wall Street Journal) that you are raising money, so long as all of your eventual investors are accredited. Before you go on an ad buying spree though, you need to know that as of right now nothing has changed.

The JOBS Act was passed in April 2012, which means the SEC was supposed to pass the rule changes necessary to enact Title II of the JOBS Act by the beginning of July. That did not happen – instead the SEC announced a meeting on August 22, 2012 to discuss the new rules. Many observers thought the SEC might present its new rules at this meeting, but instead it now looks like the SEC is going to present proposed rules and provide the public time to comment.

This delay likely has implications for the Crowdfunding exemption as well, since it shows the SEC is not taking the revision of these rules lightly. In all likelihood we are going to get a good preview of the Crowdfunding rules well before the SEC puts them into place.

Should Lawyers Take Equity in Startup Clients?

Tue, 24 Jul 2012 11:28:00 -0400

Here’s a situation I’ve seen over and over again: A prospective client walks into the office and tells me about her business. She spent months planning and developing, she quit her day job and is working full time on developing the best product she can. Finally, she is “ready” to talk to a lawyer, so we meet and discuss what she is working on and how I can help.

Then the discussion turns to fees. At least 50% of the time she asks me “will you take equity instead of cash?” When I was practicing, 100% of the time my answer was “No.” The founder then stares at me with a funny look on her face. After all, she’s read the posts that say “Save cash, it is best to convince your service providers to be paid in equity.” She’s also read that some very prominent startup firms do accept equity in lieu of payment and also invest in some well-known incubators (and even have funds to invest in clients). So… why is this person who claims to be a startup-friendly lawyer refusing to take equity? Is her idea not good enough? Am I desperate for cash to make rent that month?

Nope, neither. As a lawyer I was not a VC, I was not in the business of evaluating whether your idea was “good” or “bad”. I had to decide if it seemed fundable, if you were committed to the business you were building and if we could work together. Basically whether I wanted to have a business relationship with you. That’s it.

Okay, but it couldn’t hurt to forgo that $4,000 incorporation fee in favor of equity, could it?

I think there are two perspectives here, first a financial perspective and second a corporate governance perspective.

Financial

As I discussed here, every major startup firm will be willing to defer fees until you raise money. That is effectively an interest-free loan until you raise money. It may not seem like a lot, but compared to giving up equity at a stage where your valuation is probably tiny it could be quite valuable. That said, often times the fees or other investment becomes equity later on, so the financial argument is rarely going to win the day for why I believe corporate lawyers usually should not invest in their clients.

Corporate Governance

When you raise money sometimes you look for investors who bring advice and contacts to the table and sometimes you just look for investors who bring money. So which category do your lawyers fall into? Well, they bring advice and contacts and they can also bring money by either forgiving debt or by actually investing in your company. So… it doesn’t actually seem like I’ve said anything that bad so far - what’s my real concern?

First, remember, part of what you pay lawyers for is their advice and contacts. You don’t need to have them as an investor to get that.

Second, let’s look at the role of a company’s lawyer. Your lawyer is supposed to advise you on what is best for thecompany. Many times that advice will jive with what is best for the individual founders and 100% of the stockholders, but at times certain stockholders might make out better in a specific deal than others, or maybeallcurrent stockholders are going to be put in a worse position because of a specific deal, but management still thinks it is an important/worthwhile deal to pursue. Would you want your lawyer to be conflicted in that situation? Even if you have total faith in your lawyer how comfortable would you feel calling him up and saying “I want you to help me put together a deal that is going to significantly harm your ownership and rights in this company”? This hypothetical is not as crazy as it sounds - in a lot of deals there are dissenters. Do you want your lawyer to be one of those?

Now, maybe your lawyer will be able to look beyond his / his firm’s interest in your company as a stockholder (which, based on his ethical obligations, he must), but that does not mean that subconsciously he might not try to steer you in a different direction. You do pay your lawyer for his advice, so don’t you want to know for a fact that advice is impartial?

Many times it works out fine to have a lawyer as an investor, but I have also seen egregious situations of lawyers truly taking advantage of a company (receiving large amounts of equity every time they bill more hours to a client, etc). You can always pay back cash, but equity is forever.

****

A couple sidenotes:

First, this post is not to say that any firm that doesinvest in clients or take equity in lieu of fees is doing anything unethical. It is only to point out the risks involved and explain why we made the decision not to invest in clients in my old practice.

Second, there might be a difference between a firm that will be representing you for the long haul and somebody doing one-off work more like a contractor. In the latter position the ongoing concerns about proper advice may not exist, but are still worth considering.

What to expect when you're expecting... a convertible note financing

Fri, 13 Jul 2012 12:45:00 -0400

I had a conversation yesterday with someone raising money for the first time and it reminded me about the black box that is the financing process. He understood “go talk to people and raise interest”, but he was not really sure about the next steps from a practical perspective. This is someone working on an angel round (so no big VC is going to lead by drafting a term sheet) that will use a convertible note.

I thought it might be helpful to lay out the flow that I tended to use while practicing. This varies from deal to deal and lawyer to lawyer, but here’s one option for the flow of a convertible note financing.

This assumes you have already drummed up some interest and worked with your lawyers to put together a draft term sheet. (I always recommend working with them from the early stages since their final documents will likely include terms that match their term sheet. This makes the final process much quicker and cheaper.)

This also assumes you are not using a Note Purchase Agreement (which tend to add cost and complexity with only limited upside for the investors… in my opinion - others will disagree).

(1) Shop around a draft term sheet and agree on the final term sheet with the lead investor. (lawyer involved here)

(2) Draft a Form of Note for the lead investor to approve (lawyer involved here)

(3) Negotiate and finalize that Form of Note. (lawyer involved here)

(4) Board approves the Form of Note and the financing in general. (lawyer involved here)

For all the steps below this line you can sometimes save money by doing them yourself, but it’s much easier if you have your lawyer handle. If you DO do it yourself you still need to make sure to notify your lawyer each time you close a Note, since there may be filings you have to make.

—————————

(5) Fill in the pertinent info for the first investor (name, maturity date, dollar amount, etc) and send them the Note.

(6) Investor wires you money and sends you back their signature.

(7) Once you have the money you sign the Note and date it the date you received the money. You keep a copy and you send the original back to the investor.

(7)(a) I never date the Note until I have money in hand because invariably some of your investors won’t send the money on the day they say they will.

(8) Repeat for each new investor. The date of each new Note will change (because that changes the amount of interest they receive), but the Maturity Date will stay the same for ALL Notes, based on the date the first Note was dated.

Crowdfunding: What You Need to Know About the JOBS Act

Mon, 02 Jul 2012 12:18:43 -0400

As many of you know, on April 5, 2012 President Obama signed the JOBS Act (“Jumpstart Our Business Startups Act”). Because startups are so freakin’ trendy right now and the media is making a huge deal of this Act I thought I’d get out some thoughts.

First, the basics:

What is Crowdfunding?

Basically, crowdfunding is funding a project or company through many (usually small) payments by a large number of people (the “crowd”). Sometimes it’s a filmmaker raising money to create a new film. Other times it is a watchmaker pre-selling its product. Crowdfunding is not anywhere close to a new concept (think of Girl Scouts going door to door months before their cookies are available, or Salvation Army setting up the red bucket at Christmas). What is new, however, is the ability to use certain internet platforms to crowdfund more effectively.

The most well known companies facilitating crowdfunding right now are Kickstarter and Indiegogo, where you can post projects to fund, but you can NOT sell stock in your company or rights to receive interest or revenue shares.

Why can’t I sell shares of my company on Kickstarter?

Back in the early part of the 20^th century people were supposedly standing on street corners hawking shares of the latest cure-all tonic and horseless carriage companies, many of which were fraudulent. After the 1929 stock market crash, this led to Congress passing the Securities Act of 1933 (the “’33 Act”) and the Securities Exchange Act of 1934 (the “’34 Act”).

Under the ’33 Act any offer to sell securities (stock, debt, etc) must be registered with the SEC or fall under an exemption. Typically this means a company can only sell securities to a limited number of un-“Accredited Investors” and cannot make a “general solicitation.”

For the past ~80 years this has meant that most companies can only finance themselves through family and friends (people they have a substantial and pre-existing relationship with prior to trying to raise money) or through developing relationships with professional investors.

What is about to change?

The JOBS Act contains a number of provisions, but for startups the most important two pieces are (1) the removal of the prohibition on general solicitations for offerings exempt under Rule 506 of Reg D. Ugh. Mouthful. Basically, you can advertise to the world that you are raising money so long as all purchasers of the securities are accredited investors. And (2) a NEW exemption to the ’33 Act via the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (the “CROWDFUNDING Act”). Clever.

Here is a list of what I think are the most important things to know about the Crowdfunding Act:

1) You can NOT raise money using crowdfunding yet!

This is the most important thing to realize about crowdfunding investments in your company. It will not be legal to crowdfund investments in your company until the SEC has come out with its new rules on crowdfunding. Congress gave the SEC 270 days (basically the end of 2012) to come out with these rules, but it is unclear whether the SEC will meet that deadline. Chairman of the SEC Mary Shapiro recently said “I don’t foresee not meeting the deadline,” but others like PandoDaily have claimed inside knowledge that the rules will not arrive until mid-2013/early 2014 at the earliest.

2) Crowdfunding is going to have to happen through highly regulated portals.

You will not be able to just post a “invest now” button on your website and collect money / send out stock certificates. Instead your ads of “Invest in my awesome company” will have to direct people to one of these regulated portals (shameless plug: I am currently involved with one called FundedCommunity).

3) Crowdfunding portals are going to have to handle a ton of information.

Every company seeking funding on a crowdfunding portal is going to have to submit to a variety of background checks and will have to file business and financial information (in some cases, audited financials) and other information required by the SEC.

4) Anyone will be able to invest using crowdfunding.

Unlike the old days (or the “current” days I should say), using the crowdfunding exemption you will be able to raise money from anyone with two pennies to rub together (up to a statutorily defined limit on the number of pennies each investor can put in based on an income and net worth requirement).

There is a lot more in the Act, so I’m sure I will write about it more as the SEC’s rules start to take shape.

What are your thoughts on crowdfunding? Would you take advantage of it to raise money (and if so, how would you choose what portal to use)? Would you invest in companies through crowdfunding?

You Are Not a Millionaire

Mon, 25 Jun 2012 09:12:00 -0400

So you own 40% of your startup and just raised $1 million at a $4 million pre-money valuation. This means you’re a millionaire, right?! Time to break out the Dom and buy a house in Aspen!

Hold your horses and let’s do a little math. Sorry to break it to you, but you’re probably not a millionaire…

This post comes from a discussion we were having on the twistlist (twistlist.co) about founders equity. Someone posted a couple cool calculators to help you determine who should have what amount of equity in a startup. One of the calculators included a result “common stock valuation”, which would output $4,000,000 in my example and I would argue is completely wrong. I’ve seen this field included over and over again in cap tables (often as “exit value” or “MY NEW NET WORTH”), so thought it worth writing about.

Okay, back to our example. We have 2 equal founders and a VC about to invest $1,000,000 for 20% of the company:

Pre-Money (meaning “before the investment”):

Founder 1 = 50% owner (common stock)
Founder 2 = 50% owner (common stock)
Valuation = $4,000,000

Post-Money (“after the investment):

Founder 1 = 40%
Founder 2 = 40%
VC = 20%
Valuation = $5,000,000 ($4,000,000 pre-money valuation + $1,000,000 cash the VC put in)

At this point you’re probably saying “Okay, I get it, Founder 1 owns 40% of something that’s worth $5,000,000, which means his 40% is worth $2,000,000. What’s the issue?!

Here’s the issue. The valuation you see is almost always based on a preferred stock valuation. The difference between a preferred stock valuation and a general valuation? Preferred stock comes with “preferences”. Owners of preferred stock get voting rights, rights of first refusal rights, and sometimes they a board seat and a host of other rights, but most importantly they get their money out first. This means that in our example if the company raises its $1,000,000 and then immediately sells for $1,000,000, the common stock holders do NOT get $800k (80%) of that $1,000,000. Instead, the VCs get their $1,000,000 back first and the common holders get zilch.

(As an aside, ask the same VC who invested to instead buy the company outright from you for $4,000,000 and the may laugh at you.)

Because of the preferences inherent in preferred stock, common stock is typically valued at 15-35% of the preferred stock valuation. So if our example startup sold 1,000,000 shares for $1,000,000 that means the preferred stock price is $1/share. In all likelihood a valuation of the common stock would find it to be worth ~$0.15-$0.35 / share. This means that each founder would own stock worth ~$300,000-$700,000. Still not bad, but not the $2,000,000 like we originally thought. Sounds odd, I know, but that’s the way it goes.

Caveats:

1) Preferred stock is not always worth more than common stock. Ideally if your company increases in value sufficiently the value of preferred and common stocks will converge. In the case of our example, assuming a 1x liquidation preference (ie. the VCs get at least 1x the money they invested back before anyone else gets money), in a sale for >$5m the common stock and preferred stock will be worth the same amount.

2) Because of Rule 409A of the tax code, there are serious tax implications to the actual valuation of your common stock. This is just a guideline and should not be relied on in any way shape or form as a way to value your common stock. The only way to potentially get a safe harbor under 409A is to have a 409A valuation done by an expert, not by reading my rants. I am by no means anywhere close to being qualified to give tax advice and am certainly not giving legal advice here.

On Living in the Startup Ecosystem

Mon, 18 Jun 2012 11:26:18 -0400

I looked in the mirror today and noticed something that made me very proud.

Let me back up. A couple years ago, when I was deep in the midst of lawyering, the partner I was working with placed her order for Birchbox. We’d been pushing to really build our startup practice in NYC (after having mostly acted in service to the firm’s startup companies from other regions) and were immersing ourselves in the NYC ecosystem. I vividly remember a great conversation we had in which we talked about the need to use our local startups whenever possible.

So today, when I looked in the mirror and realized I was wearing shoes from a Boston flash sale startup, a watch and socks from Birchbox Man and glasses from Warby Parker I had to smile. I could have gone a little further, but I have a soft spot for Banana Republic…

When I needed shoes, I ordered from a friend’s company. When I was thinking about getting a new pair of glasses I automatically gave Warby Parker a chance. Thankfully they delighted me and I was able to buy. And of course, when I needed to feel pretty I went directly to Birchbox Man. Not to mention the Quarq powermeter on my road bike, which was just a small startup fighting the big boys until its recent acquisition, and countless other examples.

Using our “shop local” mantra has not always gone this well. When I was practicing law, a registered agent startup pitched us (these are the guys who act as your proxy in Delaware and other states where you might be incorporated, but not actually have an office). They told us about how they were a startup too, and about how our clients would get great deals and great service at the same time. After carefully evaluating (this was for our clients after all) we decided to give them a shot. We wanted to love them. They were half the price of the other guys and talked a big game. Unfortunately after a few months of frustration we had to give up on them. I was bummed because we wanted it to work out so badly, but we ended up incurring more costs by cleaning up messes. We wrote off the time so the clients didn’t get stuck with the bill for our trial, and I was happy knowing we gave them a legitimate shot.

It’s important to remember that there really IS a startup community. Not only are we are all out there trying to build products and bring them to scale, but we are also all trying to help each other with their products (just look at the recent excitement over all the NYC exits in 2012). This is not just a matter of getting coffee and helping a friend of a friend talk through her growth strategy. It is being that first customer, taking that first chance on a newcomer and trying something a little different. That’s how we are building a sustainable community.

So I’m not saying you have to live, breath and eat startups. You don’t have to use that clunky new search engine if you’ve tried it and it doesn’t work for you (but consider telling the founder why you don’t want to use it). You don’t have to buy an ugly t-shirt just because a startup is selling it. But before you make your next purchase or set up your next service, think about using a startup (particularly a local one). Don’t make the purchase if you don’t feel comfortable, but at least think about it.

Working With Lawyers Part 1: How to find a startup lawyer

Sun, 10 Jun 2012 23:50:09 -0400

Working with lawyers is a huge pain in the ass. They’re expensive, you never know exactly what they’re doing with all that time they’re billing you for and you never know exactly when they’re going to get back to you. In some ways working with lawyers is like outsourcing your work to a foreign country - you don’t know the language or the customs, yet you are trusting them with a core part of your company. Hopefully this and future posts on the subject will help. (Note: I’ve titled this “Part 1” for ease of reference if I do choose to write another post on this. Hopefully I will, but maybe I won’t… we’ll see.)

Tip 1: Ask for recommendations in the startup world.

Trust me when I tell you that you don’t want to be a law firm’s first / only startup client. That’s not to say you don’t want to work with a junior associate at a firm with a partner reviewing the work, in fact you might have the most fulfilling experience that way, but you want to make sure SOMEONE knows what they’re doing there! One horror story I can tell you about is a company that came to me only after another firm had spent a long time working on their documents, documents that looked like nothing any modern-day NYC startup lawyer would produce. This firm had wracked up a huge legal bill for a deal that should have cost a few thousand dollars. Documents from the first tech bubble deserve to go the way of Webvan.

Tip 2: Fixed fees are usually your friend (in the early stages).

Law firms offer fixed fees because they may make you more comfortable hiring the firm, since you know exactly how much they cost. When a firm offers a fixed fee to a startup the firm is frequently “losing” money on the deal (ie. billing by the hour would make the firm more money). Most very early stage legal work is not complicated enough that a law firm will not be able to judge the complexity well enough to offer a fixed fee. If the firm you are talking to suggests a high fixed fee or will only work hourly you might want to talk to another firm (Note: There are occasions firms will have a harder time giving a fixed fee, like if you are trying to do a complicated LLC structure. You can probably forgive the firm at that point.)

Tip 3: Deferral Deferral Deferral.

This is perhaps the most important tip of looking for a law firm to do your startup company’s work. EVERY firm that focuses on venture-backed startups will defer its legal fees until you raise funding (ie. you do not owe anything if your company goes out of business). Many will also defer between rounds of financing. Deferral works like this. Say your incorporation (including restricted stock agreements, stock incentive plan, etc) costs $4,000, you incur ~$2,000 in hourly fees for your terms of service and a couple other minor things, and then you raise money using a convertible note, which costs $5,000. After you close the convertible note financing you will get a bill for $11,000. Then you will frequently not get a bill again until you close your next round of financing (but do not be afraid to ask for monthly updates so you know how much you are incurring).

The reason firms that focus on startups do this is that they are “investing” in you, not by taking equity, but by deferring your fees. The economics work out like this. If you are paying the firm a lot of money when you don’t have a lot you are less likely to succeed. This means that you may go bankrupt or may just go to a smaller firm that will charge less, which means the big firm will lose your business. The big firm does not really care about having to write-off $5,000 if your company goes under (and will frequently welcome you back as a client for your second startup). The big firm really cares about the fact that if you stick with them through a sale your legal costs may be $200,000, and if you stay with them through an IPO your legal costs will likely be well over $1,000,000. Yes, 1 million.

Do you want a firm that is incentivized to see you sell / IPO or would you prefer one that is really concerned about getting $5,000 from you as soon as they file your incorporation papers?

I Would Like to Congratulate Facebook on an Extremely Successful IPO

Mon, 21 May 2012 14:23:04 -0400

There has been a lot written about how the Facebook IPO was a huge flop because the stock price did not “pop” the day of the IPO, and in fact it went down (and is still dropping). Far from being the sign of a flop, I think this is actually the sign of a great IPO.

A company’s IPO generally serves two purposes, first and foremost it is designed to raise money for the company. This is why Facebook would sell $12b in stock, rather than just $100 million. Second, the IPO is, in part, designed to give liquidity to investors and employees of the company (something secondary trading markets like SecondMarket and Shares Post have already started to do).

So where did the Facebook IPO fail? First, the company raised a huge amount of money in the public markets (and unlike in the private company context, in the public markets you generally are not picky about the “quality” of your investors). The decrease in stock price actually shows that Facebook raised this money at what is likely the highest possible valuation it could have achieved at this point. Second, Facebook provided significant liquidity for its investors, since the company is now public with a large float.

The Facebook IPO was a “flop” for a small number of traders trying to capitalize on a “pop,” but for Facebook, the company, I would argue the IPO was wildly successfully. The people who were hurt by the lack of “pop” were generally extremely wealthy individuals and institutional investors who could actually get into the IPO. The IPO process is not about maximizing value for these individuals, it is about maximizing value for the company IPO’ing. As a former corporate lawyer who constantly had to help founders recognize the difference between maximizing personal value and maximizing their company’s value, the results of this IPO warm my heart.

So without further ado I would like to congratulate Facebook on an extremely successful IPO.

Both Sides of the Billable Hour

Mon, 07 May 2012 09:01:04 -0400

Mark Suster writes a great blog called Both Sides of the Table about being an entrepreneur then a VC. When I first used a law firm for my own startup I got to thinking about the similarities between going from entrepreneur to VC and lawyer to entrepreneur. Besides moving up the foodchain from very uncool —> cooler —> super cool (admittedly I started a little further down that chain than Suster…), there are some interesting things you realize when you are on the other side of the billable hour. Some are things I know I did when I was practicing, some I hope I did, and some I probably did not…

My first realization: Unless proven otherwise, treat every entrepreneur like they are a first-timer.

I filed my first trademark this week, and of course went to Jen Berrent at my old firm WilmerHale. She was kind enough to put me under the firm’s QuickStart program, which included a low-cost trademark application, and then put me in touch with the trademark team there. Although they all knew me, and knew that this work was at a low fixed cost, they took the time to explain the moving pieces and what they all meant. They assumed I knew nothing unless I told them otherwise, and they did a great job improving whatever work I had done on the application. I’m hooked. I already had a predisposition to work with WilmerHale, but now I will definitely go back.

I think this attitude applies to the startup world as well. Especially when you are just getting going you need to treat every customer and lead like they are your only customer or lead. Even if you have the simplest product in the world, take the time to explain it just in case. At FitPack we have realized that even though our product is not that complex in our minds it usually takes prospective customers a minute to “get” it. No matter the athletic experience level of the customer we are taking all the time in the world to help each customer understand how we can help.

For more on this check out this great post by Carly Strife over at BarkBox on the point of decision.

"How does it feel to not have a paycheck anymore?"

Tue, 01 May 2012 15:12:17 -0400

I think this is the most common question I received for the first few weeks after quitting my law firm job to run FitPack. It makes sense, but truthfully it was kind of an odd one. To me it didn’t feel any different… because I hadn’t actually missed a paycheck yet.

I used to get paid on the 25th of every month, so until last week I was living just like I always had (albeit maybe not eating out as much). I hadn’t moved out of my apartment. I hadn’t stopped my hobbies (in fact I was training and bike racing more than ever). I just hadn’t gone to 399 Park Ave in a few weeks…. Unsurprisingly this all changed on the 26th. That day when I had to transfer rent and credit card payments from my savings into my checking instead of just letting that come out of my direct deposit. YIKES.

I guess the reality of this life is starting to sink in slowly. I’ve been working on building an awesome product and experience for our customers, but missing that paycheck on the 25th reminded me that I need to get out there and SELL! This post from Forbes on biz dev could not have come out at a better time. http://www.forbes.com/sites/christophersteiner/2012/04/24/biz-dev-is-a-clever-name-for-dirty-work/

Now back to selling!

"We need fewer lawyers and more startups..."

Wed, 18 Apr 2012 22:14:07 -0400

These great words of wisdom came from a client of mine back in January. He and I were chatting about something for his company and then the conversation turned towards my side project:

Client: “So when are you quitting your job.”

Me: [Thinks “This is awkward.” Says:] “Haha I don’t know…”

Client: “We need fewer lawyers and more startups.

So I took my client’s advice. April 18th and here I am “self-employed.”

I spent the last 3.5 years working as a corporate lawyer. I represented all manner of companies from the earliest stages through to public companies. My favorites were always the startups - a few co-founders coming in with an idea, or maybe a prototype, and nothing else. With those companies I got to be a lawyer, a teacher and an advisor every day I talked with them. Because so much of the work was flat fee or written off anyway, I could often ignore the clock and just help them work through their issues. I loved that. I did this kind of work from the moment I started at WilmerHale, but the percent increased over time. In January 2011 another lawyer I worked closely with was promoted to partner and she decided to devote nearly 100% of her time to startups. I got to go along for the ride!

Over the next 15 months I was able to hone the skills I’d been developing and spend more and more time working with just startups. It was fantastic, but left me knowing that it could only last so long. I had gone to law school with the thought that I would practice law to learn about companies and meet founders before jumping ship to start my own company. As a Senior Associate I had developed the skills needed for lawyering, but was getting dangerously close to becoming fully enmeshed in a career that although I really enjoyed, did not match with my life plans. So I had to choose whether the world needed more lawyers or startups…