When I began my legal career in 2003, the median pre-money valuation for a high-tech company raising a Series A financing was around $10 Million and the company’s legal fees for a Series A financing could be expected to exceed $50,000. Twenty years later, the median pre-money valuation for a high-tech company raising a Series A financing is around $50 Million and the company’s legal fees for a Series A financing rarely exceed $50,000. Even controlling for the size of the round, the cost to companies of early-stage venture capital financing has dramatically declined over the past two decades.
It is no coincidence that 2003 is also the year the National Venture Capital Association (NVCA) published its initial set of model legal documents for Series A financing transactions. Prior to 2003, every venture capital firm had its own preferred set of terms and every law firm representing venture capital firms had its own preferred set of legal documents. The NVCA’s model legal documents – created by a group of venture capitalists, lawyers and other industry insiders – gave the venture capital industry in the United States a common standard against which the proposed terms of any financing could be easily evaluated. In the intervening years, the NVCA has regularly updated the model legal documents to reflect changes in the industry and the law. While every venture capital firm still has its own preferred set of terms, and every law firm has its own preferred set of legal documents, most now take as their starting point the NVCA’s model legal documents. I believe it is not an exaggeration to say that the creation and frequent updating of the NVCA’s model legal documents has been a significant factor in speeding up financing transactions, reducing transaction costs and making capital more accessible to founders.
If there is one downside to the development of widely accepted terms and model documents, it may be that making it easier to agree on terms means parties often do not spend enough time considering the effect of those terms in the particular situation. Early in my career a company that received a term sheet would carefully review every term in consultation with the company’s counsel and might negotiate for weeks before signing the term sheet. Now, it is not uncommon for founders to sign term sheets without ever consulting a lawyer. This is bad for the founder because it gives investors a clear upper hand in negotiations, particularly if the founder is unfamiliar with standard terms and, more importantly, how the interplay between terms impacts how decisions will be made and how money will be split in an exit. It is also not good for investors because they often do not learn of the founder’s concerns until after the lawyers have prepared the initial drafts of the definitive transaction documents, at which point the negotiations are often more fraught, more time consuming and, as a result, more expensive. My hope is that this pamphlet will not only help you better understand standard terms in a venture capital financing, but also help facilitate discussions between you and potential investors that will ultimately lead to understanding, if not consensus, and better outcomes for everyone.