In talking to hundreds of startups each year, I know something like this is running through many first-time founders’ heads:

“Legal schmegal! I’ve got a company to build… I’m sure an all-nighter over the books is enough to clean them up before a VCs due diligence. I promised my co-founder he’ll be “fairly compensated” if we get acquired. So I’m good, right? I don’t need to spend my much-needed cash on a lawyer.”

Au Contraire, mes amis. You’re building a business. Working with a lawyer in your early stages can prevent a lot of sweat on your brow later down the road.

THE VALUE OF LOOPING IN A LAWYER:
Unsure about working with a lawyer when you’re first kicking off?
Here’s a few key reasons working with a lawyer can be incredibly valuable:

They help you get your share structure right and properly document it the way investors expect. Straight from the get-go. If you’ve ever had to go through a company re-structuring, or tried to clean up mistakes at the time of a financing or sale. it’s painful. Avoid it at all costs. A clean, well documented company makes for easy due diligence and faster (and less expensive!) deals.

They can help you make sure you actually own and continue to own the IP that makes your company work. Really good ones can help you develop licensing and partnering strategies you can use to get paid.

They have connections. Run away from any lawyer who promises to get you financed, but do look at firms to see who they’ve helped negotiate deals with. Is their Rolodex packed with potential investors or customers? Can they make a warm intro and get someone to focus on your business plan or get you candid feedback?

They can raise red flags and help you fix them up BEFORE the due diligence process.

STARTUP LEGAL ADVICE:
To help you out, I spoke with Ivan Gaviria, a partner at the Silicon Valley office of Gunderson Dettmer, a law firm that focuses primarily on entrepreneurs, emerging growth companies and venture capitalists. Now, Gunderson’s army isn’t your typical team of lawyers. We’ve worked with them on numerous occasions, and they are authentic, cool, business-savvy folks. They kind of people you want in your circle of real-life friends (not just your 500+ facebook friends).

Ivan laid out a number of tips and legal advice for startups. If you have further questions, let me know and I’ll be happy to connect you with Ivan or a member of his team.

TERM SHEET 101
Definition: A Term sheet is typically a non-binding commitment to do a deal based on the terms laid out in the term sheet.

Benefit: The deal isn’t binding until definitive agreements are signed, but the term sheet allows the parties to reach agreement on key deal points up front and (hopefully) makes for a more efficient and cost effective deal with lawyers working on fine points and not hashing out major business issues, says Ivan.

A Common Misconception About Valuation: Ivan says there’s a common misconception among startups that valuation is the most important item on the term sheet. The truth, he says, is that startups shouldn’t get too hung up on small differences in valuation and should focus on choosing the right partner. Especially in the early going, getting an active, engaged VC with domain expertise and with whom you have a good fit can make a huge difference in building a successful business and weathering the ups and downs that every start up will inevitably face.

What IS the Most Important Term? Don’t get bogged down with boilerplate terms such as registration rights that have little economic impact and are highly standardized. Focus on the liquidation preferences, says Ivan, and understand the fine print.

In the context of a venture financing, a “liquidation” is deemed to include a sale of the company (via merger or otherwise) or a sale of its assets, and the liquidation preferences govern how the proceeds of such a sale are distributed to the stockholders.

Do the preferred investors get their money back first – ahead of the common stock typically held by management? Twice their money? Three times? Do they get to take their money of the top and then participate in the distribution of the rest of the proceeds along with the common? When does an investor’s downside protection turn into a double dip? Seemingly minor tweaks in this section of the term sheet can have an enormous impact on how much a founder actually receives at the exit.

Ivan points out that with the current state of public capital markets, startups are finding more than ever that selling their company is the far more common path to liquidity than an IPO. That makes it all the more critical to understand and carefully negotiate liquidation preferences.

Many thanks to Ivan and the Gunderson Dettmer team. If you have questions or want to connect, let us know!

ABOUT GUNDERSON DETTMER:
Gunderson Dettmer is a leading law firm for entrepreneurs, emerging growth companies and the venture capital firms that support them. With 125 lawyers in four offices – Silicon Valley, Boston, New York, and San Diego – we represent companies in every stage of development from incorporation through entry into public markets and beyond. We provide counsel on general corporate and securities law, mergers and acquisitions, venture capital services, intellectual property, strategic alliances, and tax matters. We combine our experience, industry relationships and expertise to provide practical, business-oriented advice tailored to the needs of the emerging growth company marketplace.