By: Jared Sorin
Until recently, New York, the financial capital of the world, was not known for being a center of entrepreneurial activity or a hotbed of angel and venture capital investment. Each of Silicon Valley, the Route 128 Corridor, and Research Triangle among others, eclipsed New York. That has certainly changed. Today, New York’s startup, early stage and emerging growth company communities are thriving and have become an important part of the economic activity and growth for this region, fueled largely by ecommerce, digital media, mobile applications, social networking, software and financial technologies. Savvy investors have responded and New York now boasts the second largest venture capital community in the country.
This startup activity offers great opportunity, but there are challenges as well. Many of the companies being formed are less capital intensive than are the companies the mainstream venture capital community is used to investing in. As a result, these companies tend to need less capital to get from inception to revenue production and positive cash flow. In turn, the investors also are likely to be smaller VC funds and angel investors. Thus, deal size is smaller, with companies often raising “only” hundreds of thousands to one or so million dollars, rather than tens of millions of dollars. This poses a dilemma – smaller deals, smaller companies, and smaller investors cannot fund the costs of lawyering that prevail in the market. But the transactions and their underlying issues are still material and often complex, requiring high quality legal services. Such services are costly and, for many, the fee simply does not make sense given deal size and relative transaction costs. Fred Wilson, renowned venture capitalist and managing partner at Union Square Ventures, has issued a challenge to startup company lawyers and their venture capital law counterparts: find a way to incorporate and close seed capital financing at a fee that makes sense. He suggests that fees for such a transaction should be $5,000 or less.
Fred’s challenge created quite the response, with vociferous arguments on both sides. The truth, however, is that Fred is right. High quality lawyering, on the one hand, and efficiency and a compelling value proposition, on the other, should not be mutually exclusive. It is up to us, as lawyers and future lawyers, to work with entrepreneurs and investors, to solve this very real problem. Failure to do so will either chill capital formation (killing new companies, reducing a critical job creation engine and lessening innovation) or force companies and investors to find alternate solutions. We need to be part of the solution. One suggestion is broad-based adoption of standardized documents. The National Venture Capital Association has produced a set of high quality documents. Standardized seed stage investment documents also are available. Use of such documents will increase efficiencies and reduce costs. But, they are not a substitute for the skill and judgment of experienced company counsel and venture capital counsel. To meet Fred’s challenge, such counsel need to work within a framework of sensible costs and delivery models that will enable the ecosystem to thrive. This means that law firms need to change the way they do business, by reducing costs that do not add value to clients, ensuring that experienced, specialized, focused counsel serve clients, and by deploying the productivity tools that our clients have developed.