Smart Startups Have Smart Cap Tables

Every company has a cap table – i.e., a record of the pro-rata stock ownership of the company’s founders and other shareholders. A fully-diluted cap table also includes rights to acquire or convert into stock ownership – such as options, warrants and preferred shares. As a startup, your cap table – not the written representation of it, but the actual ownership and rights to acquire ownership in your company – is the most important “asset” you have. Manage it wisely and guard it carefully, because no matter how valuable your company becomes, that value belongs to the people in the cap table.

I am continually amazed at how carefully some startups protect their IP and business plans but how careless (or sometimes, carefree) they are with their cap tables – handing out stock like it’s a free sample at the grocery store or a sale item in the bargain bin. The problem is, those free samples and discount prices entitle the recipient to a permanent stake in the company and all of the related upside.

Think of stock as the lifeblood of your company. It’s not something to pass out to impress or thank your friends or to issue the landlord in lieu of rent. It’s not a cheap substitute for money just because your company is cash poor – all startup companies are cash poor. It IS money; but it’s money that will hopefully increase in value exponentially over the life of your company as a result of your ideas, dedication and hard work. Make sure you retain enough ownership to enjoy the fruits of your labor.

Let me be clear – I’m not suggesting that it’s realistic to believe most startups can (or should try to) succeed with the founder retaining 100% ownership. What I am suggesting is that you carefully manage your cap table and only share ownership with those investors and key employees who provide the essential ingredients for your success.

Understand What No Lawyer or Document Can Do For You

I was recently helping a client with a stock purchase in a deal that just felt wrong to me. Each time we asked a question or reviewed a document, it seemed additional issues, questions and concerns arose. Notwithstanding this fact, the investment bankers, company officers and selling stockholders assured us in each instance that there was no problem – usually with the excuse that it was simply bad record-keeping, a lack of attention to detail or a favorable related party transaction that would not adversely affect the company or my client going forward. In fact, they said, it was precisely because of these circumstances that my client had been presented with this amazing investment opportunity. I did not find these explanations to be persuasive or reassuring, even when the sellers agreed to provide a litany of warranties and representations, broad indemnification rights, and other contractual protections.

In this circumstance, I was compelled to explain to my client a very simple fact – while a lawyer can draft an all-encompassing contract in which virtually every possible risk is anticipated and addressed with detailed indemnifications, aggressive remedial provisions, escrows, etc., that does not turn a bad deal into a good one or provide the same level of protection as walking away from a bad deal.

The simple truth is, if your due diligence yields more questions than answers more uncertainty than certainty, and more risks than opportunities – and if you find yourself spending an inordinate amount of time and effort trying to protect yourself from known and unknown legal risks and possible bad behavior or misrepresentations by the other party (versus ordinary course business risks) – no amount of lawyering and no legal document can adequately protect you. In that case, you really only have 2 choices – (1) walk away from the deal, or (2) draft that over-the-top contract with all of the bells, whistles and protections and “hang on for the ride.” And if you opt for alternative 2, understand that a good lawyer and a good contract do not make a good deal.

Does Your Business Need a Little “Spring Cleaning?”

Spring is an exciting time. It signals the end of a long, dark and sometimes dreary winter and the beginning of a new season of growth, opportunity, color and activity. It’s also the time when many of us make a long “to do” list filled with tasks that we tackle with energy, enthusiasm and excitement – knowing that truly the seeds we plant today will yield a bountiful harvest some time down the road.

Unfortunately, very few of us have a similar seasonal signal that it’s time to clean up, get organized and plan(t) for the future. Instead, we’re so wrapped up in the day-to-day activities of running our businesses that we never get to the “spring cleaning.” Since spring is literally upon us, I want to make a pitch for a seasonal sprucing up from a business and legal standpoint.

As business owners, you know far better than I what sorts of projects will most benefit your businesses – but I’ll take a shot at identifying some that might yield value (while sticking with my spring cleaning analogy):

• Reset the Clocks – businesses and their owners need to reset priorities and revise strategies from time to time, or you simply run out of time in the day.

• Clean Out the Garage – businesses develop “clutter” just like households. Take the time to clean up and eliminate it so that it doesn’t distract you from your mission.

• Plant the Annuals – annuals are like near term goals for a business. With a limited amount of effort they can blossom and yield immediate benefit, but only if you do the groundwork at the right time and in the right way.

• Plant the Perennials – perennials are more like long term business objectives. They require more planning and nurturing than annuals, but yield long term rewards.

• Do It Yourself and/or Hire the (right) Lawn Service – this is a big one. As the owner, you need to decide where your time is best spent and who the right people are to handle the rest. Do what you’re best at and enjoy most and hire the rest. BUT, don’t hire the first service that sends you an attractive brochure. Make sure your advisers understand you and your business.

Spring is a time of great energy and promise. Make sure you harness both for the benefit of your business.

Know Where You Want to Go Before You Start

You’d never leave on a family vacation without knowing where you’re going and what you’ll do when you get there. So, why would you begin a business negotiation without knowing what your objectives and acceptable outcomes are? My answer – you shouldn’t.

So, am I saying you need to know exactly where your negotiations must conclude before you even begin discussions? Of course not – negotiations necessarily involve multiple parties, all of whom have their own goals and expectations. It would be foolish to think you can predict and control all possible outcomes, and short-sighted and unrealistic to believe the only successful outcome will be exactly the one most beneficial to you. After all, successful negotiations almost always require give and take from all parties to ultimately arrive at a win-win arrangement. Without this, at least one party will, presumably, have no incentive (or not enough incentive) to do the deal.

What is critical, however, is that you not enter into negotiations without giving careful thought to what your objectives are, the ways that you might be able to achieve them, and the outcomes that would be acceptable. Note that I’ve said objectives, ways and outcomes – plural. Just like the old saying, “there’s more than one way to skin a cat” – there’s almost always more than one way to structure a business deal.

I recommend you follow these basic suggestions before entering into business negotiations:

• Identify your ultimate objectives – the primary reasons you’re considering this deal.

• Consider the various ways that you might be able to achieve those objectives.

• Identify your secondary objectives – things that would be nice to get, but are not essential.

• Consider the various ways that you might be able to achieve those without compromising on the primary objectives. Also consider things that you would view as deal-killers.

• To the extent you’re able, go through the same analysis from the other party or parties’ perspective – see the deal through their eyes.

• Now, once again, consider how you can achieve your primary (and hopefully secondary) objectives AND how the other parties might also achieve theirs. Hopefully there are several ways to get there – some of which may be more or less desirable to you, but all of which would be acceptable.

• Having gone through this exercise, it’s now time to negotiate.

Remember, your best way to achieve a successful outcome is to consider what that might look like before entering into negotiations, rather than looking back and wondering what went wrong.

Sign Your Deal NOW!

I’ve seen it happen a thousand times – in fact, I’ve seen it happen twice this week.  Parties to a negotiation reach a “deal” but don’t have documents ready for signature.  So one party takes responsibility for drafting them, but by the time drafts are circulated, one or both parties change their position, back up, get cold feet, reconsider, or whatever else you want to call it – and the deal falls apart.  While that’s not always a bad thing, it often is, and it is also frequently avoidable.

Now, I’m not suggesting that parties hastily enter into deals or sign incomplete or inaccurate agreements.  But, I am saying that well thought out and carefully considered deals are often at their best – that is, closest to the actual “meeting of the minds” that we lawyers talk about – right after negotiations are complete.  This is why it’s important to move quickly from negotiations to definitive documents, to execution. 

Remember, the name of this blog is BizB4Law – when negotiations are complete (and assuming they were well thought out and comprehensive), the “biz” portion is in most cases complete – all that is left is the “law” portion.  While the documents should spell out the business terms agreed to and fill in gaps, it is generally not productive to reconsider or reopen the negotiations – and doing so often means the parties lose the “benefit of the bargain” they had just made.

So all of this means we should follow a few simple guidelines, as follows:

• Make sure your negotiations are as comprehensive as possible.  Discuss and agree on all material terms.
• Include your lawyers as early as possible in the discussions.  If that’s not possible or productive, include them just prior to preparing definitive documents – so that any specific open issues or questions they may have get answered before the parties conclude negotiations.
• Draft definitive documents as soon as possible after negotiations are complete, and stick as closely as possible to the terms agreed to in negotiations.  The document stage is not the time to surprise your prospective business partner.
• If you feel you have to change something from what was agreed to or address something important that wasn’t previously discussed, let the other party know before you send them proposed documents.
• And finally, move from first draft to final draft to execution as soon as possible after negotiations are complete.

These are pretty simple guidelines, but they will help you to avoid disputes and get your deals done.

The Fine Line Between Lawyering and Over-Lawyering

If you’ve read this blog often, you’ve hopefully figured out that I view myself as a practical, pragmatic lawyer who takes a businesslike approach to the practice of law.  That means a lot of things, including only providing the amount of “lawyering” that a deal needs – in other words, avoiding “over-lawyering” a deal.

I don’t think you’ll find the word over-lawyering in a dictionary (even a law dictionary), but I think every client knows it when he or she sees it – I just wish every lawyer did.  Over-lawyering may be one of the biggest reasons people dislike and avoid lawyers; and here’s another shocker – it’s also one of the biggest reasons lawyers like me dislike working with certain other lawyers.  At a minimum, over-lawyering makes deals take longer and cost more than necessary; at its worst, over-lawyering causes deals not to get done.

When I say over-lawyering, you may immediately think I mean a lawyer providing more legal services than necessary in order to produce more billable hours and therefore a bigger legal bill.  While that certainly can be one reason for over-lawyering, I’m not talking just about that (in fact, I’m not talking about that much at all, because I find it to be ethically and morally reprehensible).  Instead, I’m talking, for example, about the contract that includes provisions that are completely unnecessary under the circumstances, either because they don’t fit the context or because the likelihood of them being triggered is so remote and unlikely as to make them a waste of time and resources.  I’m also talking about 3 page paragraphs to describe what can be said in 3 lines. 

Most contracts are intended to memorialize the parties’ promises, duties and obligations after there has been a meeting of the minds.  The negotiations and ultimate contract should cover those terms and the real risks and likely outcomes and stop there.  Say it once; say it clearly; and be done.  Anything more is over-lawyering.

It’s the Client’s Deal – Make it Happen

One of the most difficult situations a business lawyer encounters is when a client wants to enter into a deal or relationship that the lawyer believes is a bad one for more than purely legal reasons.  After all, the most beneficial and rewarding attorney-client relationships are those where the client views the attorney as not only a legal advisor, but also as a member of the strategic/management team and a trusted confidante.  As such, the lawyer is faced with a dilemma – advise the client of the concerns and the reasons for them (which can be risky for the relationship), or simply go along with the client’s wishes and execute the deal while, of course, protecting the client as much as possible.  This situation is fresh in my mind, as I have dealt with it in the past week.

In reality, while I agree this is a challenging situation, the appropriate course of action is relatively clear.  In my opinion, the lawyer should absolutely share his/her concerns with the client and the basis for them.  This should not be done subtly or for the mere purpose of covering the lawyer’s backside in the event the deal or relationship ends badly – rather, it should be done so that the client is fully informed of the attorney’s concerns and can carefully consider them.

Once the attorney has advised the client of his concerns comes the next step – what if the client wants to proceed with the deal anyway?  I’ve found that different lawyers take different positions in this situation, but my position is clear – so long as the client’s position is fully legal and ethical and the client is fully informed, my job is to make the deal happen and protect the client as much as possible.  After all, it’s the client’s ideas, creativity, risk tolerance and ultimately money that have allowed the client to be successful and that are at risk in any business deal – not mine.  Just like the customer is always right, the client is always the one who should make the final decision and bear the final responsibility for a business deal.  My job is to advise, inform, protect and execute.

Finance, Strategic Planning and the Practice of Law

As I spent most of my day today developing our law firm’s budget for the upcoming year – something I’ve now done 13 times – I thought, every business lawyer should go through this process at least once. And as we budgeted for items reflected in our firm’s strategic plan, I thought – every business lawyer should go through that process too. Finally, as we discussed overall firm management issues, I thought – every business lawyer should have the opportunity (and the responsibility) to be involved in and accountable for the management of a business.

Perhaps you’re thinking that I mean preparing a budget, participating in strategic planning and being involved in management would be beneficial to lawyers in better understanding their own firms – and of course they would – but actually, the reason I think all business lawyers should participate in these processes is to better understand their clients and their clients’ businesses.

All of our corporate clients must think strategically, operate on a budget, and confront management issues on a daily basis. Furthermore, those that have the deepest and most valuable relationships with their business lawyers directly involve those lawyers in these matters – treating them not as mere legal consultants, but as trusted business advisors and confidantes. How can a lawyer fulfill that role and justify that trust if he or she has never actually dealt with these issues in a real life situation? – where they not only have to makes these decisions, but also communicate them to their colleagues, persuade others to buy into them, execute them, and ultimately be accountable for the results – including business, financial and human consequences. That’s the experience I want my lawyer to have. That’s the experience I’m glad I have when advising clients.