The following is a blog written by Auren Hoffman (CEO of RapLeaf, and co-founder of BrightRoll and AdRocket). Auren spoke at a recent roundtable in the Valley about startup strategies for cutting costs and staying lean.

For the origainal post, go here. Thanks Auren!

legal fees: most important term sheet clause

When most entrepreneurs get a term sheet from a venture capital firm or a group of angels, they tend to focus on the valuation, share price, liquidation preference, option pool, board member set-up, etc. All of those are really important.

But if you are trying to get the deal done quickly and want to save your company some money, you should also focus on the clause about the legal fees of investor’s counsel. Typically, start-ups have to pay the legal fees of the venture capitalists. This is a great deal for VCs to save some money when they invest in deals.

In the companies I am involved in, I’ve seen a huge range of dollar amounts for the legal fees for investor’s counsel. an angel deal typically is $10k. VC round is likely $20-30k. the longer the company has been around, the larger the amount (because that usually correlates to the more corp governance issues a company has and the less vanilla its structure is).

As an entrepreneur, you should fight hard to reduce this legal fee clause. Here’s why:

First, you want to save your company money.
VCs typically are not great stewards of cash. They typically pay more for everything than an entrepreneur would … they always pay full price. Plus, if you are paying their legal fees, they don’t have enough incentive to haggle with the lawyer over hours billed. I can’t prove this empirically, but my guess is that the ultimate bill from investors counsel is usually within 3% of the cap in the term sheet. So if your clause says you will pay up to $30k to investors counsel, expect to pay at least $29k.

Not to be outdone, your counsel will use investor’s counsel’s fees a barometer for their own fees. Your lawyer will typically charge 150% of investor’s counsel (since they are doing a lot more work). So if you are paying investor’s counsel $30k, you’ll likely pay your own counsel $45k – for a total of $75k. if you are only raising $3.5 MM, you just paid a 2% fee off the top to the lawyers.

Now if you were able to negotiate $20k to investor counsel, you may only pay your own lawyer $30k – for a total of $50k – thereby saving your company $25k for the same deal.

Second, a much more importantly, the time it takes to close your deal will vary on how much you pay your investor’s counsel.
If you cap investor’s counsel’s fees at $30k, they will have a much greater incentive to nit-pick over little items than if you cap them at $10k. my formula is:

Time it takes to go from term sheet to close = 20 days + 1 day for every thousand dollars you spend on investor’s counsel.

You probably can never close a venture deal in less than 20 days (assuming the company has at least some history). And for every thousand dollars you pay investor’s counsel, they essentially can postpone the deal from closing one more day to increase their fees.

This might sound cynical and anti-lawyer. It isn’t meant to be. There is no proof of this theory – only from my own personal observation. And I’m sure this doesn’t apply to ALL lawyers. And it might not apply to YOUR lawyer (who you presumably like and think highly of). But you don’t know the investor’s lawyer and thus should be wary that they might postpone closing to increase fees. Not consciously, of course. But subconsciously, humans tend to go to the right wall boundary.

With this in mind, as an entrepreneur, you should fight to lower investor’s counsel. This, of course, is the one clause YOUR lawyers will almost never advise you on (they’ll probably do a good job on advising you on the other important clauses). Which is why it is so important that you, the founder, spends a lot of time on this.

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