Edwin Miller of Sullivan and Worcester recently published an article called Time to Reboot the Basic VC Deal Structure, in which he argues that we should radically change the way VC deals get done. In his words:
"New York Times columnist Tom Friedman recently suggested that “It’s Time to Reboot America,” meaning that the financial crisis gives us a chance to fundamentally re-examine the way government and the private sector operate. Perhaps it is also time to re-examine the basic venture capital deal structure that has changed little since the 1970s.
A related issue is bloated legal documents. Simple forms that address only realistic scenarios are desirable. Sensible legal documents do not have to paper to death every one-in-a-thousand scenario. Simple, common-sense documents are easier for all parties to understand and be comfortable with, and they are cheaper and quicker to negotiate and sign. This approach may be a competitive advantage, or if broadly accepted, would promote a better outcome for all parties."
He had me at "bloated." For those readers of my Law Firm 2.0 series, it should not come as a surprise that I think today’s legal documents are indeed, bloated. Edwin’s thesis that many of the terms included and negotiated in today’s financing documents are unnecessary, irrelevant and / or just plane crazy is both thoughtful and correct.
If you are interested, you should read the article. He addresses many of the major deal points found in VC financings. I agree with most of his assertions, but feel compelled to push back (quickly) on a few of them.
Registrations Rights: I couldn’t agree more that any time spent negotiating reg rights is wasted time for entrepreneurs and venture capitalists and billable hours for lawyers. However, I have been in situations that I’ve needed demand rights on a company that blew a filing and was no longer eligible for S-3 registrations. I’m very far away from being a public company lawyer, so perhaps this doesn’t matter any more, but did then.
Anti-Dilution Rights: I am a VC, so I’m clearly biased, but I wouldn’t agree to the termination of Anti-dilution rights. I think they are appropriate for two reasons. One, there are large information asymmetries between a VC and a company and no amount of due diligence will ever put a VC into the same knowledge shoes as an investor. Second, I’ve seen situations where a new potential VC to the company (who wants to invest in a lower priced round) teams up with management to try to squeeze out an early round VC. They promise management an option refresh making them whole and the new VC would get an outsized share of the company. For this reason, I want the protection to protect against such opportunist behavior.
Liquidation Preferences: Alright Edwin! I’ll take your new paradigm. Problem is that I don’t think that I can find high quality entrepreneurs who will agree to this.
Founder Guarantee: I think that I’d rather keep how we operate now in that there is no guarantee of ownership, as I think that properly incentivizes management.
That being said, I love the concept of dumbing down the NVCA model documents and making things easier. Ediwn, nice job and keep the ideas coming.