i would prefer to eliminate legal fees entirely by using standard docs and not negotiating them on either side. we have done that many many times and it works great. all you need to do is use a standard template. most law firms have them.
this is what i propose on every seed and series A we do. most entrepreneurs take us up on it. and then we don't even use a lawyer on our side.
however, there are cases, like one you and i have exchanged emails on recently, where a legal issue comes up that is created by the entrepreneur's counsel, that requires a lot of work and sometimes we end up getting stuck with the bill on it.
in situations like that, i like to have the discussion of who should pay the bill up front and on a case by case basis
The net effect is that they're being more honest about how much they're actually willing to invest, correct? They don't magically have more money and the lawyers have to be paid anyhow. At least it puts the onus on them to keep their negotiations to a minimum.
There are two groups that benefit, portfolio companies and the VCs' LPs. The former get to keep more of the money that's invested, and the latter are no longer being charged for expenses in addition to the management fees they pay.
In practice, the startups' own legal expenses will probably also be lower. In the bad old days, lawyers on both sides would engage in a leisurely and expensive back and forth, knowing they'd both get paid out of the amount invested. But if the VCs have to pay their lawyers out of their own management fees, they'll instruct them to make the negotiations fast and simple, which will in turn decrease the billable hours on the startup's side as well.
Okay, so I got it half right. They've made the consumer of services and payer for services the same (themselves) and thus they have the proper incentives. This is a bigger win for the startup ecosystem than I had previously thought.
The bad old days are still alive and well in insurance and banking. Bankruptcy is even worse.
Eight years in the insurance world has shown me that the two biggest law firm "bad behaviors" are excessive billing and multi-party meetings. Both of which, as noted, VCs will be in a stronger position to refuse to pay.
I call this version of the principal-agent problem the "new boat problem." When a partner wants a new boat, she/he bills more hours.
Even more pumped for YC interview on Sunday after reading the comments.
this. If I give you $8 and ask you to pay me $2 for expenses, or I give you $6 you don't much care. This would only apply to entrepreneurs who don't know that term sheets are less attorney fees.
meta: in the interests of continuing intelligent discussion on HN, please just say what you mean instead of "this". It's an infection that's been spreading for at least a few months here.
That's the problem cited, though. Hacker News, as a community, has developed a comical, pathological aversion to any sort of agreement. Every nit must be picked – otherwise the discussion fails to be "intelligent."
I love how you suggest that people should stop behaving the way they are in order to "use your own words, be authentic". How is altering their behaviour in order to satisfy someone on a forum being authentic and using their own words?
1. On the authenticity scale, meme language is at the very bottom. Anything is an improvement.
2. I didn't tell them what to say, only what not to say. Putting words into their mouth might have been inauthentic, but that's not happening here.
3. Just because people are "behaving the way they are", doesn't make it authentic. In case you haven't realized, we live in a world filled with constant sophisticated attempts at mass behavior modification. We are all victims from time to time, and behooves us to at least be introspective and aware of when we are. (not that meme language is a part of that, it's more an accidental artifact of networked humanity, but point generally applies).
4. Using memes is a rhetorical crutch for lazy writing.
You responded with 32 words to a 37 word post so that you could quibble about a single word, or 3% of that post. While preaching on the righteous subject of "intelligent discussion," no less. So if we're going to complain about empty calories, I'm pretty sure you're winning that game.
This is exactly right, but I prefer the $6 case because it makes it much more obvious what is going on. We should make the truth obvious whenever possible.
Hopefully (as pg points out) the next thing to go is the weird way that employee option pools are handled.
The truth is that lawyers are being paid, whether it comes out of your pocket or mine. It's very generous but as a person who has never received a term sheet at all, one way or another I see it as turning another part of the process more opaque.
Actually, that's not entirely true. If lawyers bill inappropriate charges, you don't have to pay those charges. Inappropriate charges include excessive hours, administrative tasks, overhead, or other charges you disallow based on your agreement (commonly called Billing Guidelines). Based on data I've worked with (insurance companies, financial services company, real estate firms) those inappropriate charges are anywhere from 5-15% of the total. Usually 5-10%.
The advantage of having the VC pay the legal bills is that they are a bigger fish and can more easily put in place and enforce the legal billing guidelines. Also, as a much more likely repeat customer, the VC will likely get better bills to begin with.
Not that a traditional VC will ever hand me a term sheet (I wouldn't approach one), but if one did and it specified that I had to pay their legal expenses, I would reject it on principle. It's rather underhanded, and I would immediately begin scouring the paperwork to see what other sleazy tactics they were employing.
If you were in a position to read / sign such a terms sheet then you may want to ask why it specifies that before you reject it out of hand.
And you should scour all the paperwork regardless of whether or not that clause was present, even better, have a lawyer that you pay (preferably a competent one) help with the scouring.
It would be particularly odd to reject it over solely that, because it's just a fixed-dollar difference. One easy way to overcome a finite difference in one part of a term sheet is to offer more dollars in another part.
All Spark is doing here is offering to cover the first $25k of legal expenses. The startup is still liable for anything above that. That's an offer worth at most $25k in additional implied investment, relative to the case where they asked the startup to cover all legal fees. Actuarially, probably somewhat lower than $25k. So maybe you should value the offer at $15k. Not nothing, but not worth overriding everything else.
Of course anyone would use a lawyer in such a situation. I'm just saying that it is indicative of a hair-splitting, underhanded mentality that would raise immediate red flags about doing business with them in the first place.
> indicative of a hair-splitting, underhanded mentality
I believe you may be wrong about that. But it appears you've now found a good match in Spark! On the down side, it may then be the only game in town for you, there are good reasons for the 'company pays fees' rule, see elsewhere in this thread for one possible reason.
As previously stated, I have never and would never approach a traditional VC in the first place for a host of reasons, this being one of them. There is no VC game in town for me, and I am perfectly content with that.
It's not underhanded if everybody knows its coming.
I was shocked the first time I saw this, but I called around and discovered that it's one of the things VCs do because they can. Since our VC was no worse than anybody else, I put it in the "fine, whatever, fuck you, but fine" category of things. It didn't end up even being in my top 10 things I'd change about traditional venture capital operations.
If you object to every fucked up thing about the system you're in, it's very hard to get the power to reform the system. I'm perfectly happy to beat my head against a wall, but I try to pick the walls that are ready to break. As Confucius said: "The Historiographer Yu was truly of straight character. When the government was just, he was like an arrow. When the government was unjust, he was like an arrow. Chu Po Yu is definitely a Superior Man. When the government is just, he will have a position in it. When the government is unjust he can roll up his principles and keep them in his breast."
So bravo for Spark for being the leader on this. It's really nice to what entrepreneurs turned investors are doing. I'm glad Nabeel didn't turn down that VC money on principle back in the day, or he might not now be in the position to try to fix this.
Considering how much time and work (3 months of back and forth on DD is not uncommon) it takes you to get to the point of getting a term sheet, I doubt it. Doubled by the fact that, until this posting, every VC I've heard of asks you to pay legal fees.
Now some add other fees on as well. This is considered less scrupulous and should be rejected. But to make things easy, ask about fees up front, not when you are getting a term sheet.
As an angel investor, always investing through a syndicate, it's just far easier to have the company pay the bill. But keep in mind that they're paying with the money that the investors give them, and that this is the EXPLICIT deal.
When I lead a syndicate deal, I am the person that works with the investors' lawyer to get the deal done. But I'm never the majority of the round (or even the largest single investor.) But being the person who retained the lawyer for the investor group, I am on the hook for the bill.
I'm happy doing the work of getting the deal papered, but I wouldn't be happy if I had to pay the whole legal bill when I'm only putting in 10-20% of the round's money.
There are two ways to share the expense:
1) I pay the lawyer then go around to the other investors asking them to pay me their piece. Anyone who has ever been saddled with being the payor of the bill for a large group of people at a bar or restaurant knows how this turns out. Some people forget, some people argue that they should pay less, and it's a huge logistical hassle creating nothing but bad feelings. I suppose I could get each investor to sign something saying they would pay me their share, but that's just more legal expense.
2) We up-front tell the company that they are paying the investors' legal bill (last time I did this, the bill was $6k, the cap was $10k: I don't do fancy deals.) The company factors this into their calculation of whether the investment structure is one they want to accept or not.
Number 2 is nothing more than a structural convenience. But without it I wouldn't take on the burden of leading deals: it would be more trouble than it's worth (note that, as lead, I get the exact same economic terms as the rest of the group, so I'm essentially doing free work when I'm leading and the other investors get the benefit.)
So I'm sticking with having the company pay the legal bill. If we're negotiating a deal and this (or any other term) seems unfair, we need to sit down and talk about it. Once my money is in your bank account and a couple of your stock certificates are under my mattress we're on the same team. We both have a huge incentive to make sure neither of us feels like we've been taken advantage of.
Before the other VC's are in that awkward position this would have to reach some kind of critical mass or tipping point.
Not only that but different sellers, vendors, sides of business transactions, typically offer different terms, features, benefits.
The standard procedure when someone brings up something someone else is willing to do, is to bring up your strong points and why that particular feature shouldn't matter that much as a differentiator. And the truth is how much does this really matter vs. the benefits of the particular VC firm?
That would be true if this were morally neutral. But when you're fixing an abuse that's justified by all participants as being standard practice, the right metaphor is not critical mass but a crack in dam.
Well put pg. It isn't that the money was that material, it just felt wrong and petty that it was being done in the first place so we wanted to fix it. Just feels silly we didn't do it a lot sooner.
Is your fund sales tax exempt? (In other words are you able to deduct sales tax from your earnings before taxes?)
If so you may just end up making the tax man happy and reducing the amount you can invest by whatever sales tax applies in your location. Depending on your process costs and deal-flow this could add up over time.
In the EU sales tax (VAT, whatever) is added to every business-to-business transaction and later refunded. If your fund is classed as financial services sector then you may be sales tax exempt. This has certain tax advantages but really doesn't help when you start to receive substantial bills (such as legal fees on a transaction of this magnitude) with sales tax added to them because you can't deduct the sales tax on your own filings.
"But when you're fixing an abuse that's justified by all participants as being standard practice"
I don't feel (given what I know about this) that it's an "abuse" or though I can absolutely see what it is viewed this way. And of course the people who are charging it are going to justify it by saying "it's standard practice" because that is the easiest way to get beyond the objection and smooth things out.
People have certain ideas of what they find right and just and don't think rationally about what it really means relative to the entire transaction.
For example you could go to a restaurant where the steak dinner costs $30 but feel it is an abuse because they want $1.50 for a glass of tap water. Or they want to charge you to use the restroom. But if you go to an equivalent restaurant which charges $35 and gives you free tap water and bathroom you wouldn't think twice (merely focusing on whether you think you got value for the $35 meal).
The reason people have to rely on arguments of "standard practice" is because they are quick and easy and get by objections much easier then a lengthy discussion. It's a time saver.
Related question: will not making this move affect a firm's ability to get good deals? I don't know the answer but it's what the firms should ask themselves.
One simple reason why most VCs don't do this is because they are sales tax exempt and so end up losing up to 21% of the bills to a bookkeeping quirk. So it's easier to pay a bit more out of the fund and end up with a deductible on the side of the company invested in than with a freebie to the tax collectors.
In numbers: if a complete process costs $100K and the investment is 2M the fund is out 2.1M. If they pay the bills from the fund directly they're out 2.1M without a sales tax return, if they pay 2.1 to the company and the company pays the bills the company gets back the sales tax so effectively this saves 20K or in this example about 1%. Not much but also not nothing, and if a fund does a lot of smaller deals this sort of thing adds up.
Not all funds suffer from this (likely Spark isn't one of them) so the ability of other funds to match this is dependent on whether or not they have classed themselves in such a way that they are sales tax exempt.
I'd imagine Spark to be able to offer exactly the legal fees less for the same amount of stock in company 'x' compared to some competitor that does it the usual way so effectively this shouldn't matter but it is excellent publicity for Spark.
While there are some US states that have considered taxing legal fees, this is certainly not the norm. Services are typically exempt from sales tax. From page 19 of California's guide to sales/use tax exemptions:
> SERVICES—The sale of services where no tangible personal property is transferred or where the transfer of property is incidental, are not subject to sales and use taxes.
The world is a LOT larger than just California. I love it how HN lumps every VC and every lawyer into the same pile as though we all live in Silicon Valley.
And I love it how you lump every HN poster into the same pile as though we all live in Silicon Valley. It's probably too late for you to read this, but you're jumping to your own conclusions...
I've been on HN long enough to recognize your nick and I was well aware that you live in Europe. You jumped into a discussion about a US-based VC firm and claimed it was motivated by sales tax. Please don't get irate just because "HN" tried to be helpful by explaining why sales tax wouldn't apply here.
And for the record, I live 5,000+ kilometers from the VCs on Sand Hill Road.
I've paid a lot of legal fees as well and they always had sales tax on them.
HN seems to be a bit myopic in this sense, that if something hasn't happened to an individual therefore it doesn't happen.
But not everybody here looks at the data through the lens of a VC and that is what we're discussing here.
In this thread VCs are equated with a cartel, the truth is they're all continuously in competition with each other rather than colluding with respect to making terms sheets that are worse for the companies they invest in.
Terms sheets are negotiable on a per-case basis, if you can get better terms with a different VC then you should go for it, there is nothing that is 'always done this way' and any unspecified cost can be made into a certainty by either putting a cap on it or negotiating a lower investment with the other party accepting the fees to be paid to be directed to them if that gives you more peace of mind.
While sales tax is usually a state issue and our disconnect may be the result of working in different states (I am in NY), you can see from the American Bar website that it's clear that sales tax is not usually levied on lawyer fees: http://www.americanbar.org/advocacy/governmental_legislative...
That link shows the American Bar saying 'Don't start charging sales tax on legal fees' which implies that they don't currently charge them.
"Currently, only three states have a tax on legal services – Hawaii, New Mexico and South Dakota"
So where do you work?
I think the myopia here is you assuming that VCs don't normally pay legal fees because it's a sales tax problem and they don't want to waste money.
US sales tax and VAT are not the same type of tax, main difference is that sales tax is paid only at the retail level (by the consumer) while VAT is paid at every stage: a company would pay VAT to acquire raw materials, retailers VAT to acquire the packaged goods and consumers VAT on the final purchase. As far as I know no US state applies sales tax on legal bills so for US VCs there is no tax issue on this
Indeed. But since in this thread all VCs are considered equal it would be worthwhile to point out that particular difference lest this leads to EU venture capital companies being branded as cartel operating vultures.
As an aside, the whole thing strikes me as a PR move rather than one with real effect, it's a zero sum game, lawyers will get paid one way or the other and there is only so much money to be divided.
Regarding VAT, what you write is misleading in that VAT is also reclaimed at every step (or more usually, offset against VAT due).
The net effect is pretty much the same as a sales tax, except the tax revenue becomes due proportionally at the step in the chain where the value is added rather than all at once at the retail level.
Indeed. The effect is the same in the end if the sales tax is paid and not avoided (e.g., no receipt). With VAT at least the taxes on the intermediate steps of production will have been paid even if the retailer and consumer are cheating at the final step.
I find this very interesting (and illuminating). I'm a little confused on what you mean by "getting back the sales tax" (probably because all I can think of is the sales tax I get charged when I buy something at the store).
For corporations it works a bit different, depending on your jurisdiction sales tax is either only added at the last stage (business to consumer) or it is added at every stage and returned back to businesses when they do their quarterly or annual tax filings.
This is going to be one of those wonderful games of iterated group prisoner's dilemma, in which one member of a formerly functioning cartel has just publicly announced an intention to always play Defect.
Could also be that the tea leaves (or winds) were reading (blowing) in this direction anyway and they decided to draw first blood in order to make the biggest splash.
True, but that also fits within the prisoners dilemma. The way the rewards are set up, you generally should defect if you think your opponent might defect. If it is an iterated prisoners dilemma and you think they will start defecting, you come out ahead if you beat them to it.
The number and types of bills we got after closing an A-round was ... illuminating. Background checks on founders, in particular, was not something I would have guessed we'd be billed for.
Good. Incidentally, the number of things popping up during such background checks that scuttle a possible deal is quite substantial.
It's not so much that there is stuff that was eye-brow raising, it is mostly a breach of trust in terms of disclosure. Sometimes founders are not honest with each other from the get-go, it wouldn't hurt for founders that feel they are in a position to hit one out of the park to have a 'full disclosure' session with each other so they know at least what if any skeletons there are in the various cupboards rather than to have a surprise late stage rejection. Those are generally bad for business.
While I've never raised money from traditional VCs, I have raised millions of dollars from angels. Out of more than a dozen angels I've worked with, never once has anyone even contemplated having the company pay the legal fees of the investor. If this is the norm, I'm glad I dislike VCs enough never to have approached them.
I've been charged legal fees by an institutional seed stage investor, though the fees were capped -- at an amount equivalent to 2% of total initial investment.
Doesn't this just mean Spark will have a little less money to actually invest, thus will need to invest at slightly lower valuations to get the same returns, and companies will accept those lower valuations because they no longer have to pay the legal bills?
Of course that's a huge simplification, and I'm in favor of reducing sneaky terms that can take entrepreneurs by surprise, so I'm not complaining.
I think it's also likely to reduce total legal expenditures. The investors previously did not see the legal bill and so their lawyers had less incentive to minimize fees.
You are essentially saying that a VC has no problem saddling up one of their portfolio companies with unnecessary costs, in other words that they are hurting their own interests.
Clearly the VCs have an interest in keeping legal expenditures down. But the extra layer of indirection does not help that goal. E.g. employers, individuals, and insurance companies all have an interest in lowering health costs, but the structure of the market makes it a difficult goal.
The very first thing that popped into my mind, though, was what happened with ArsDigita. I don't think they've agreed to not use the company's money when suing the company's CEO.
This is exactly what I was thinking. Seems like a cost that will be recouped somewhere. Perhaps some startups dont mind that. I don't know enough to have an opinion on its merits. I would imagine some startups may not mind footing the legal bills if it means saving in some other way.
I would absolutely without question go with the investment with the fewest hassles. Even if it meant a smaller initial dollar amount (within reason), there's a lot of value in simplicity.
I wander if they are paying the $25k from management fees or from the fund.
The justification for why VCs don't pay their lawyer bill has always been that they don't want to take the money from their management fees, if Spark has figured out how to take it from their fund and their LPs are okay with that that is good.
If not then they are footing $25k from their pocket. But I guess if they only do 10 deals a year their max liability is $250k which isn't bad for a $450m fund.
Heard at an event last night that for one company, the legal cost to include UPS as a strategic investor actually exceeded the amount they invested but the company chose to do so in order to access UPS data.
Being entrepreneur friendly is so central to VC marketing that this effort will likely pay itself as a PR expense.
Also, transaction fees are typically presented as being deducted from the capital being moved, as opposed to just charging the company. Of course, net it's the same. But language matters.
If that's how they wanted it to look, well, fair enough. But I don't think it is. I wonder how much time and effort is spent building style sheets that end up rendering as nasty as the results I got?
"Doesn't paying the legal bills for the other party create some conflicts of interest or other weirdnesses for the lawyers?"
This happens quite frequently in insurance defense situations. Say a Physician is hit with malpractice and the insurance company is paying all legal costs. (Or even auto insurance as maybe a better example).
The important thing to remember, is that you are the client ("the insured") and even though the person paying the bills will attempt to get you to use an attorney that they have already worked out rates with it is within your right (going along the lines of the point you raised) to get another attorney, within reason, price etc. (The price doesn't have to necessarily be the same either.)
In my humble opinion this barely scratches the surface. But it is better than not investing, so I hope you and they do well with it.
I'm personally interested in projects that flip the incentive structure for people to use lawyers for tasks of all kinds, not just startup-related ones.
Alternative Fee Arrangements (AFA) are becoming more popular in the insurance world. An insurer will hand over substantially all of their plain vanilla cases in a certain line of business (usually workers comp) in a specified geography to an outside counsel firm. That firm is paid a fixed fee per case, not per hour. To protect the firm, the firm is allowed to "opt-out" of some number of claims each year and bill those claims hourly.
Insurers are reporting significant savings. Law firms that get the work are happy. The rest... not so much.
Love that this is #1 on HN and I'm going in for my YC interview on Sunday to explain how we can help insurers, banks, and VCs (and apparently startups) reduce their legal expenses.
It's a sign!
For a more substantive comment, moving the legal bills into the hands of a "bigger fish" is bad news for law firms. VCs are less likely to be willing to pay for over-billing, unnecessary tasks, and other bad behavior. (shameless plug) VCs, especially those that use my team's software, can save a bundle on legal fees with very little effort.
This is nice for larger funds to do, with fatter management fees. Smaller funds, not so much so.
There's not really a structure to take it out of the fund commitment, so this comes out of management fee. Smaller funds don't have this luxury though - if you're running a microcap fund, you simply don't have $250k free in your management fee budget for something like this. That's the salary for another partner really.
I always understood that the company receiving the money is supposed to pay it's own fees and use a lawyer that it trusts, without taking money from the VC on grounds that if you use the VC's money, to pay the VC's lawyer, on the VC's terms, you aren't necessarily getting a fair deal. I think paying your own legal fees to an impartial third party is a prudent investment. Perhaps I'm just naïve.
The problem they're describing is a little different.
Your lawyer always works for you. You pay them with the company's money. Which is also generally investor money. But that's ok; your lawyer will be very clear that they work for the company. (Which, it important to note, is different than working for the founders.)
Here, VCs require you to pay their legal expenses for doing the deal. So when the deal closes, they send you a bill for their lawyer. The VC's lawyer definitely knows who they are working for: the VC.
One of the problems with this, besides the you-must-be-fucking-kidding-me factor, is that the VC's lawyer has no incentive to keep things quick. The VC has a very slight incentive to speed things along. But if it's coming directly out of the VC's books, then hopefully they'll keep a tighter reign on all the last-minute stuff that somehow hasn't been made standard and turns what you'd think would be an easy thing into a $25k bill.
Startups are slowly but surely getting more power/respect when fundraising. This is excellent, and hopefully the "heavy-handed VC oppressor" will go away for good some day...
