These questions, or something like them, may lurk in the minds of many investors and university technology transfer managers when they get bogged down in negotiating the final documentation of a spin-out transaction. In a slightly different context, a US fund manager recently challenged lawyers (in his blog) to charge a fixed fee of $5,000 for advising on a seed-round investment transaction. To quote from that blog:
We closed an investment recently. It was a seed round. Our firm priced the round and we were joined by a number of small VCs and a few well known angels. We agreed to close on a standard set of “light preferred” documents without negotiation. There was no investor counsel on the transaction. We just signed the standard documents which were tweaked to reflect the round size, share price, and board provision in the term sheet.
The legal fees for this transaction were $17,000. I talked this over with the entrepreneur and we agreed to pay the legal bill. We are both big fans of the law firm involved and felt they earned their fees on this transaction.
Despite feeling that the lawyers earned their fee of $17,000 on that occasion, the author considers that a deal of this kind should be do-able for $5,000.
There are now hundreds of comments on that blog posting, many from lawyers who advise start-ups. Some query whether a standard deal is ever achievable, given the diverse interests, expectations, and levels of experience of the parties concerned.
Here are some observations in the context of UK start-ups that are spun-out from universities.
1. It would be good if a standard investment agreement could be developed, that parties would readily adopt. This would certainly streamline the process and make it easier and cheaper to “paper” the transaction. We included a simple subscription and shareholders agreement in the UNICO Guides that we prepared in 2005-6, which was based on an Imperial Innovations template. We haven’t seen it used much, though.
2. In our experience, the expectations of investors and their lawyers vary widely. Consequently, deal terms vary widely. Some professional investors take a “corporate” approach, and might be amenable to agreeing standard deal terms. Other investors are more individual in the way they negotiate deals.
3. Universities can be just as bad, having no clear set of negotiating guidelines and “making it up as they go along”. Thinking through policy issues in real time as negotiating proposals are made is a very inefficient way of using expensive lawyers’ time.
4. There is sometimes a strong element of education in the discussion over deal terms – explaining to both parties what particular terms mean, and their implications. It may also be necessary to explain the other party’s priorities – universities and investors are not natural bedfellows. This is a time-consuming activity that deserves proper remuneration.
5. Parties have a habit of creatively negotiating terms without involving their lawyers. Sometimes, a specially-negotiated term that seems simple and can be described in high level terms in a sentence requires a page of complex drafting in the agreement. Early intervention by an experienced lawyer can divert the parties from adopting a solution that is expensive to draft. We have recently advised clients who have dramatically changed the basis of the deal in a brief conversation, then just as casually changed it back again. Agreeing key terms in a term sheet then sticking to a “plain vanilla” approach thereafter requires a disciplined approach, which is not always present.
6. This is not to say that lawyers are blameless. Some do have a habit of taking a standard (and sometimes over-engineered) approach to every transaction, whether or not it is commercially justified. Universities and investors need to get better at selecting efficient, cost-effective law firms and giving them clear instructions not to adopt a Rolls Royce approach.
In these circumstances, it is a brave lawyer who offers a low-fixed-price service. I know how I (1) would make the deal quick and simple, but there are at least three other stakeholders involved that I cannot control: (2) my client, (3) the other party, and (4) the other party’s lawyer. I have sometimes tried to get (2) and (3) to give strong instructions to (1) and (4) to keep things really simple, but with varying degrees of success.
Do readers have any suggestions for how to keep the costs down?