TheFunded's Ideal First Round Term Sheet: A Critique

Earlier this week, TheFunded Founder Institute released a model term sheet intended for venture-oriented first round financings. In his post announcing the term sheet, Adeo Ressi of TheFunded credited the blogosphere for inspiration; a recent post by Chris Dixon and others by Fred Wilson are among those supporting the idea of standard first round terms. (I'll link to TheFunded.com's post announcing the term sheet here, but their site is closed and I think their post will not be accessible unless you have paid a subscription fee.) The goals of the communal project (if I may so idealize it; there are substantive disagreements among those in the dialogue) are to (a) strike a fair balance between and among the interests and concerns of founders, companies and venture capitalists, and (b) standardize terms so that legal costs can be controlled (all agree that the legal fees typical for Series A rounds are way out of proportion to the amounts being raised).

No question, legal fees for first round financings are too high and need to come under control. Standardizing a term sheet won't hurt that cause, because, to the extent there is more overt industry consensus about what terms are fair to ask for and expect, and what "asks" are truly extraordinary or exceptional, key terms should be concluded quickly, and fewer ambiguities will have to be confronted and worked out in the process of drafting the definitive deal docs. But, simply in terms of controlling legal costs to document and close a first round deal, here's what would help more:  standardizing the stock purchase agreement.

In fact, the flavors and variations of term sheets are fairly well known. So, for that matter, are Investors' Rights Agreements and the arcane registration rights provisions and multiple indemnification provisions they contain (there is surprisingly little variation in the boilerplate language for these provisions, once you have key terms settled on). Even the better proportion of charter provisions (in Washington, we refer to a domestic corporation's charter as its "Articles," and for a corporation formed in Delaware the charter is called a "Certificate") have pedigreed boilerplate language that most securities lawyers are loathe to change for fear of unintended consequences (there are exceptions -- we could use tighter standardization of the wording of a proliferating variety of preferred class protective provisions that are a key part of the Articles or the Certificate, as the case may be).

The stock purchase agreement often ends up being the most highly customized document in the suite -- which is odd, in a way, when you consider that the document is destined to soon be backward looking. In particular, the reps and warranties from the company to its investors that a stock purchase agreement contains consume a huge proportion of the time spent preparing deal docs. Ideally, drafting the stock purchase agreement would take no more time than amending and restating the Articles or the Certificate, a document which, at least in a company going places, will be a living, governing constitution, referred to and relied upon for the life of the venture, long after the stock purchase agreement ceases to be relevant.

The NVCA has a model stock purchase agreement (available as a Word doc!), and I wonder if another effort in the spirit of TheFunded's model term sheet might be to work from this model agreement to create standard variants of the reps and warranties, with a goal of setting more overt norms about what reps are typically fair to ask for and to receive. Now, I am not talking about putting form over substance in terms of disclosure. Disclosure from a business perspective should be a matter of the credibility and integrity and candor of the players; from a technical legal perspective, disclosure should be a function of the PPM, or the business plan with some thoughtful risk factors, together with a good disclosure schedule and appropriate investor due diligence. But if the industry more readily agrees about, say, a suite of standard IP reps, maybe we will spend fewer days customizing, for example, another firm's "no open source" IP reps when the company being funded is an SaaS businesses?

At the end of the day, I suspect that in order to succeed the project is going to require a full suite of standard documents, a full suite of variant provisions, and probably also some commentary to speak to the intentions and purposes of one variant over another. All of this should be accessible and manageable online, and hopefully not balkanized among too many different law firms (I am a big fan of the Wilson and Orrick term sheet generators, but those are first generation apps and need to be improved and opened up further). I don't know if the others in the blogosphere are contemplating this, but, as I see it, the lawyer's value will be delivered as much on the front end of the deal -- the term sheet -- as in the quality control of the output of the deal documents. (In my experience, founders, companies and investors are all better served, and legal fees are lower, when lawyers come in at the term sheet stage, weigh in on how it is shaped, and take co-ownership of the instructions for the deal.)