Let’s Not Get Ahead of Ourselves with Standard Terms

Last week, serial entrepeneur/angel investor Chris Dixon set off a bit of a flurry when he blogged about “Ideal First Round Funding Terms.” His central theme was that there are certain terms for early-round investments that should just be stock simple, so investors should just use an experienced firm (Gunderson, Wilson Sonsini, and Fenwick are the three he used as examples) for two reasons: inexperienced firms/lawyers will over-lawyer the deals to death; and subsequent investments will be more efficient because they’re starting from known ground.

It was quickly picked up by a host of other VC bloggers, all of whom vociferously agreed.

We think they’re forgetting something.

Dixon thinks that the following provisions are so standard as to be pointless to negotiate:

• investors get either common stock or non-participating preferred;
• investors get pro rata participation rights in subsequent offerings;
• founders get accelerated vesting on change of control;
• the board should consist of the manager, an investor rep, and an independent;
• founders should get “subsistence” wages (enough to live on but not to save anything);
• friends & family/angels should get the same economic rights but none of the control that the first “real” investor gets;
• 10-20% option pool;
• everything else (reg. rights, etc.) should be on the NVCA standard terms.

The two things that get negotiated are valuation and amount raised.

For all of that, the financing should be done for $10,000 in legal fees.

Fred Wilson of Union Square Ventures was one of the first to pick up on Chris’s idea. In fact, he was surprised to see that he, who is exclusively on the investment side, agreed so thoroughly with Chris, who more often than not is on the founder side. Fred also raves about the Gunderson documents, and thinks the deal should be done for $5,000.

Brad Feld of Foundry Group picked up the baton. He’s got some experience in the area of trying to standardize terms, so we’ll just quote his summary of the work done in the area so far:

When my partner Jason Mendelson and I wrote our Term Sheet series in 2005, we had a lot of people thank us for demystifying the term sheet.  Some time last year, both TechStars and Y Combinator open sourced their financing documents –TechStars were done in conjunction with Cooley Godward and Y Combinator’s were done in conjunction with Wilson Sonsini.  On top of all of this, the NVCA (National Venture Capital Association) has had a set of model legal documents up on the web for a while (Jason was on the team that put these together).

So – there’s now no shortage of term sheet data (and forms) available.  Now the trick is to get everyone to start using the same stuff.  It seems like first round deals is a great place to start.

Michael Arrington of TechCrunch (himself a reformed O’Melveny/Wilson Sonsini veteran) reported on yet another source of standard terms, from investor-rating site TheFunded, and

Feld then went back to the well, celebrating all these sources and turning toward the heavy lifting of standardizing the terms.

This all sounds well and good, but look at who the cheerleaders are: successful, experienced investors and founders.

See the problem yet?

Go back and look at those terms. Pretend you’re a 23-year old kid who has been hacking away in Ruby on Rails 20 hours a day for the past four months. Do you really have any idea what non-participating preferred is? You’re about to sign over your life’s work (remember, you’re just 23) and a Gunderson lawyer is telling you, “don’t worry, it’s all standard.”

These terms are well within the bounds of standard good practice (although look at all the variation, even when people are deliberately trying to draft a “middle of the road” set of documents), but we know that because we’re experienced lawyers who have done these deals.

But could you really, in good conscience, just advise your “client” to sign off because those who came before have reached some sort of loose consensus on what the terms should be?

We’re all for standardizing the documents and bringing the costs down, but let’s not do it at the expense of actually educating the founders and letting them be obstinate pains in the ass on things they feel passionately about.

And one thing we absolutely agree with (and we’ve been guilty of it) is to at least steer them toward experienced firms. Yes, there are lots of smart, sophisticated lawyers in New York, but they’re not adding any value by negotiating the registration rights provision in the first round (or pretty much any subsequent round for that matter).

Too much time and money can get spent over-lawyering these things, but we just want to bring the clients back into the conversation.

Related posts:

1. WSGR Term-Sheet Generator
2. Wall Street Even Owns Tech Deals
3. Quick Shucks – 6/17/09
4. This Week in Layoffs – 1/30/09
5. Layoffs in Vault 51-75