I am pleased to welcome officially Susan Morgan to our team. Susan has 10+ years of sophisticated corporate law experience, including 7+ years at Fenwick & West in Silicon Valley where she closed more than 30 private financings; she is an Adjunct Professor at Golden Gate University, where she teaches a course on Business and Legal Issues in High Technology Startups; and she is a highly successful entrepreneur, having co-founded two software companies. (You can learn more about Susan’s background on her bio page.)
For Susan’s first assignment, I asked her to review and comment on the new “Series Seed” financing documents posted by Ted Wang and the related posts by Brad Feld, Fred Wilson, Yokum Taku and Jason Mendelson. Indeed, I concurred with Jason in the comments section of his post that “there will never be a standard set of seed documents” because of the lawyers and their own self-interest (as I discuss in my VentureHack’s post “Top Ten Reasons Why Entrepreneurs Hate Lawyers”). Susan, however, surprised me and actually sided with Ted and Brad and their optimism. Below are her thoughts. Many thanks, Scott
Series Seed Documents
By Susan Morgan
Much has been written recently regarding the concept of standardizing a “lite” version of first round financing. The compelling idea is that a small, early-stage “seed round” financing should not include all of the massive documentation, negotiation and legal expense that accompany a more substantial later financing round. Ah, but the problem is that each law firm (and institutional investor) has its own well-used and well-loved proprietary set of form documents which they trot out as the starting point for any financing. Because these forms are of a “one-size-fits-all” variety, they tend to include all of the complex, intricate and specialized terms that might be appropriate to negotiate in a later-stage financing, but needlessly drive up the costs and complexity of an early-stage seed round financing.
How to solve this problem? Enter the “lite” versions. Over the past couple of years, several attorneys and/or law firms have created a publicly-available, “stripped-down” set of form financing documents which eliminate some of the “less essential” terms for an early stage seed financing and thereby streamline the process and reduce costs. The most recent iteration of such documents are the “Series Seed” documents post by Ted Wang, an attorney at Fenwick & West (my former law firm). In fact, a recent post by Brad Feld lists four such sets (including Ted’s) and proposes that we “finish the job” by getting “everyone” in a room together to hammer out a single set of final terms and documents, which the entire industry can then standardize around. A nice idea, but will it work?
Jason Mendelson (Brad Feld’s partner) thinks not. In a recent post, Jason predicted a stunning failure of this effort to standardize. Why? Because Jason believes that the two constituent groups that will need to come to agreement on a standardized set of forms (i.e., lawyers and VCs) are, to some extent, inherently motivated not to do so. Lawyers like to put their own proprietary stamp on things (including these seed financing documents), and VCs tend to trust and support the lawyers they have hired to protect their interests. Jason fears that an all-day meeting with 50+ lawyers (who would all insist on being included) and any number of VCs and other parties will deteriorate into an “ego fight” – each participant insisting on including his or her own special tweaks into the documents. Jason’s fears are not entirely unfounded – he has witnessed this before in drafting sessions of the National Venture Capital Association (the “NVCA”) for their model venture capital financing documents.
So, should we abandon this effort as a potential waste of time? I don’t think so. For one, we should consider re-defining what we mean by “success.” If our only standard for success is perfect agreement on a single set of seed documents; well, then that is a very high standard indeed and we just may not reach that. But why should that be our only gauge of success? I would propose that we have already reached some measure of success! Just look at the term sheet comparison produced by Yokum Taku. There is far more agreement in terms among these term sheets than disagreement. In fact, it’s not hard to take the next step and put together a composite term sheet (with some alternative terms, as the NVCA does) that encapsulates everything in this comparison. The composite term sheet would look like this:
Seed Financing Term Sheet
|Name of security:||Series __|
|Principal documents:||COI, SPA, IRA (or Bylaws)|
|Dividend preference:||Pro rata with common|
|Liquidation preference:||1x non-participating|
|Anti-dilution:||None or Broad-based weighted average|
|Board composition:||2 common; 1 preferred (with some minimum holding for preferred)|
|Protective provisions:||Changes in preferred only; or Changes in preferred and merger/sale of assets only; or Typical list for company-friendly VC financing|
|Information rights:||Unaudited annual; or add quarterly|
|Right of first offer on new financings:||Yes|
|Right of first refusal and co-sale agreement:||None; or Assignment of company right of first refusal to investors|
|Drag-along:||No; or Yes (founders and preferred), triggered upon (i) majority of common, (ii) majority of preferred, and (iii) board approval|
|Future rights:||(2 = yes, 1 = no)|
|Legal fees:||None; or ~$10K to investor counsel|
Of course, this hasn’t melded the underlying text in the documents together, but if we do no more that just get everyone (or a core subset of attorneys and VCs) to agree on this term sheet as a starting point, we have already achieved a significant milestone! In one quick stroke, we have eliminated a considerable volume of drafting and negotiating: anti-dilution provisions, registration rights provisions and legal opinions – gone. This alone would save entrepreneurs a huge chunk of legal fees. And I would propose we use that as our measure of success – i.e., how much money we save entrepreneurs.
So, I don’t know whether an all-day drafting session can get us to full standardization (or even a little closer to that goal), but it certainly seems worthwhile to keep the conversation going. As Ted so aptly put it in his comments to Jason’s post: “[L]et’s not give up just yet! Let’s talk about ‘standard seed documents’ and see where that leads. It may take years, but I’ve got a long horizon.” Who knows, maybe an all-day drafting session will yield some random pieces of conformity that will, at least, save the entrepreneurs some amount of legal fees. And that, by my definition, would be a success.