Crowding Lawyers Out of Startup Financings

Startups raising seed funds struggle to keep legal costs down.

The cash a new venture needs to launch, especially in the web industry, often is modest. But with some notable exceptions, lawyers are reluctant, or unable, or unwilling, to scale fees back to be proportionate with the size of the financing.

Entreprenuers - and their angel and VC investors - don't want stock issued without complying with securities laws. But they also don't want to spend $20,000 on a $400,000 seed financing.

Fred Wilson famously issued a $5,000 legal fee challenge to lawyers: do the seed round at or under that cap. Lawyers (like me) squirm, because in the popular entrepreneurial mind, a lot of stuff (organizational work, IP assignments, reverse vesting negotiations, terms of service, the first licensing agreements, reviews of vendor contracts) can get lumped into that budget as "clean up" incidental to the financing.

Leaders like Ted Wang have shown up to address the problem: his "Series Seed" deal docs go beyond the standardized term sheets (almost every incubator and angel organization has a favorite) and give companies and their investors an actual set of contracts that can be customized (but, ideally, not negotiated!) and signed. Deals in Seattle using Series Seed have been done for $7,500. On the other hand, some firms can't resist "improving" the forms, and fees approach what you'd have with negotiated documents.

Comes now crowdfunding! This is the phenomenon of raising small amounts of capital in small increments from many people. Kickstarter is a poster child for it. Local company Rotomotive is using Kickstarter now to raise money. But Rotomotive can't issue stock its supporters. Wouldn't it be cool if startups could actually issue stock to supporters via crowdfunding?

Changes are coming to US securities laws that will make that possible. Last week, the House passed a bill to authorize a federal securities exemption for crowdfunded offerings. Senator Scott Brown has introduced a similar bill in the Senate (with some huge differences, though; more on that very soon). Because the Obama administration has endorsed the House bill, it's likely that a crowdfunding exemption in some form will become law.

Lawyers hate the idea. I can't find a single one who would represent a startup for a crowdfunded offering. What we worry about are the unsophisticated investors who, experience strongly suggests, will be the first to later say they did not understand how risky this all was, that they though the IPO was imminent, that things have changed and they need their money back now.

A lot will turn on the details of the final crowdfunding legislation, but Sen. Brown's bill is promising in this respect: it will require crowdfunded offerings to be conducted on a crowdfunding platform, and charge the platform with performing basic due diligence on the entrepreneurs who use it, and on the deal terms offered. If they're smart, the platforms will determine a standard set of deal terms.

Crowdfunding, the investment version, will give entrepreneurs an alternative to "friends and family" (for which there is no actual exemption) and to accredited investors (angels) for their initial seed funds. Done right, crowdfunding will also solve the problem of legal fees - by making lawyers unnecessary.

Image by Los Angeles Personal Injury Attorneys.