Lawyer Up: In Priced Rounds, Don’t Skimp on Your Legal Plan

Trying to cut costs by engaging a generalist attorney may lead to bigger problems that take more time to solve — and will have you paying extra in the long run.
Samuel Garcia headshot
Samuel Garcia
Expert Contributor
October 15, 2020
Updated: October 16, 2020
Samuel Garcia headshot
Samuel Garcia
Expert Contributor
October 15, 2020
Updated: October 16, 2020

If your startup is conducting a priced round — a mechanism for raising equity by offering investors shares at a fixed valuation — it can be extremely tempting to try to save money by hiring an attorney who isnt a specialist in this area of the law.

Allow me to share why you should avoid this dangerous mistake.

Recently, I was in the middle of negotiating a term sheet for a priced round. My team and I felt like we were close to a deal. The only major hurdle left was for the startup to send the term sheet to their counsel and for their counsel to mark it up on their behalf.

The term sheets we use at Amplo are standard and should require light rewording or edits at most, so it’s a red flag if we get back a term sheet with a huge amount of edits. When we got the revisions back on this term sheet, the changes weren’t just numerous, they also didn’t make much sense for the needs of a startup. It wasn’t a great sign.

 

Convertible Notes vs. Priced Rounds

Founders generally choose between two options for equity financing: a convertible note or a priced round. Notes — which are essentially loans to the company instead of a purchase of shares based on an agreed-upon price — are generally faster. Notes may not always require a lawyer (especially if they’re a standard SAFE), but priced rounds absolutely do. That’s because priced rounds are actually pretty complex and use a lot of paper.

Founders may also want a lawyer for a priced round because that lawyer often becomes the startup’s corporate counsel, and if they’re sharp, they can be great legal and business advisors. The catch, however, is that most founders are cost-conscious, and they’ll often look at legal needs as a place to save. It makes a lot of sense: The fees usually make up quite a large line item.

Related Reading5 Mistakes People Make Building Their Startup’s Financial Model

 

Why You Need a Specialist

I have seen founders try to shave costs here by doing things like hiring a family friend or bringing on anyone who will agree to work cheaply and happens to be a lawyer. This can work in the beginning, but when you finally raise a priced round, you need to retain a law firm that actually does startup work.

When you raise a priced round, you will be amending and negotiating a term sheet, stock purchase agreement, voting agreement, right-of-first-refusal and co-sale agreements and various other documents, depending on your particular situation. If you are working with a firm that does startup work they will have precedent for all of these documents that they can easily format to match the terms that were agreed on in the term sheet. If you are not working with a firm that does this work frequently, this process will be drawn out and painful.

 

Avoid Unnecessary Pain

Why can this process be painful? Every time there is a back-and-forth about terms between you and the fund, it adds days to the timeline for when the deal closes and the funds are wired. If your counsel doesn’t produce documents that very closely match the term sheet, then you can expect to add weeks. It’s also not the greatest way to start off your relationship with the fund you’re working with because of the nature of the ask and the heavy lifting required.

So what did we do about the legal scenario I mentioned earlier? We had a candid conversation with the founder about why the startup needed to engage counsel that had a lot of experience in this area. Luckily, the company followed our advice and decided to retain separate counsel for its priced round.

They were shocked at the value a specialist firm added as they went through the process. This expert counsel significantly cut down back-and-forth — while relieving our concerns and building our confidence that the documents would actually reflect the term sheet.

In the end, the lawyer they retained became a valued advisor of the company: an unexpected and useful bonus. For the sake of your sanity and your long-term bottom line, heed this example and don’t skimp on counsel when you’re raising a priced round.

Read more from Samuel GarciaIs Your Startup Guilty of Shoddy Legal Analysis?

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