The Legal Side of Raising Money: Startup Funding Questions Answered, with Anna Tharrington

As a startup founder, raising money can feel like an enormous mountain to climb. Many go through dozens or hundreds of pitches before they find the investors that will say yes – and are truly the right fit.  And when the deal comes and the cash hits the bank account, the time spent and stress involved are all worth it.  But what about the legal ramifications of raising capital?  How do you know that you’re set up the right way and that you’re protected?  On today’s episode, Hutchison PLLC’s Anna Tharrington provides tips on the legal side of taking investment money.

Transcript

Trevor: Hey everyone, before we get to this special live episode with Anna Tharrington, I wanted to share a special promotion we’re running. 

Inspired by the Robbie Hardy episode where she shared the unbelievable story about how she used a magic 8-ball to help her decide whether or not to sell her company, we are giving away a Hutch 8-ball to anyone who writes a Founder Shares podcast review. All you need to do is write a review on Spotify, Apple Podcasts or wherever you listen – and let us know by sending an email to podcast@hutchlaw.com.

Trevor Schmidt:Hello, and welcome to the Founder Shares Podcast. We’re so happy that you’ve chosen to spend some time with us. I’m your host, Trevor Schmidt. I’m an attorney at Hutchison law firm in Raleigh, North Carolina. We work with founders and entrepreneurs as they fight, grind, stress and push to bring their visions to reality. We are inspired by their incredible stories of success, failure, reworking and trying again.

Trevor: A few episodes back I had on my partner, Justyn Kasierski, and he and I talked about some of the biggest mistakes that we see startups make at different stages in their company. And if you haven’t already checked out that episode, I encourage you to do it because there’s just a lot of great content there in.

But today we’re going to zoom in a little bit and talk about one particular topic, something that is really one of the engines of a successful startup, and that’s money. How you make it, who you get it from and what you’re giving up to get it? And that’s why I’m so excited to have my law partner, Anna Tharrington here with me today, because not only is she just a great person, fun to hang out with, but she has just got extensive experience with all things related to angel and venture financing.

It just is a delightful person to talk with. And so, I’m so excited that you’re here with me today. So welcome Anna. 

Anna: Thanks Trevor. I really appreciate that. some pretty big shoes to fill after coming in. after Justyn. So really appreciate you having me. I’m excited to talk to you. 

Trevor: Okay, great. Well, so tell us a little bit about you and your practice and what people need to know about you.

Anna: Yeah, so, so hopefully folks familiar with our law firm. but we specialize in working with what we call growth companies. So typically, in technology or biotech, life sciences. And those companies, you know, they may vary with what they’re working on, but most of them have a common theme in terms of needing representation for forming the companies and setting it up, helping get funding, which we’re talking about today. And then also if our clients do well, for us, a lot of times that means helping our clients get sold. And so, my practice is one of the general corporate practices at Hutchison with a specialty sort of focus in on this financing and fundraising piece, which is again as sort of a common thread for most of our companies.

Trevor: Yeah. When would you say that when you represent companies for financing, what does, what does that look like? Kind of, what is your day to day. 

Anna: So, it all starts, you know, piggyback and again, on Justyn’s talk with you, it all starts with sort of our general business and corporate representation of clients.

Um, and as they grow, you know, fortunately, or unfortunately most of them have to take outside capital of some sort in order to grow and scale their business and to get to that ultimate sell, which is what most of them are going for. And so, for me, in a day-to-day way, there’s a lot of general corporate guidance and getting companies ready to raise money.

And so, you know, often we hear from founders that they spend a decent amount of time sort of getting ready for funding, a lot of time trying to get checks in the door, and then a little bit of time enjoying it and rinse and repeat, do it again. And so, we’re involved with that in a host of different ways, ranging from sort of getting the companies cleaned up as they started to thinking about financing and fundraising.

Also, sort of as they move into deal mode, helping, you know, do quality scrubs in their documents and then also helping with the actual legal documents and general business advice around that as well. 

Trevor: Yeah. And there’s a lot in there that I want to kind of dive into as we go on through this conversation, but the real critical question: what is it that your kids really think that you do on a day-to-day basis? 

Anna: I love this question, and it’s a great one. So, my kids are eight, almost eight next month and six. And so, it’s evolved over time. It went to just that I type things, but I think now the newest, newest description from the older son is that we play a lot on the computers and get to wear Air Pods.

And so, I think he’s convinced that I may be a super gamer or something, a closeted gamer, but he seems interested, told me, wanted to be an attorney the other day so that he could play games on one of his monitors. So that will be it probably sending emails and wearing Air Pods. 

Trevor: There you go, I think, you know, he should be hired as a recruiter for law schools. If that’s what he thinks attorneys are doing. 

Anna: Job market, yeah. 

Trevor: So, my youngest right now, I think her most recent description of what I do is stare at the computer and do a bunch of boring stuff. So, I think you’re, at least he’s got a positive view of what you’re doing, so that’s good. 

So, talking about kind of financing or fundraising that companies might do. How much can you talk a little bit about the different types of fundraising or different ways that a company might bring in money and when, or why a company would choose one over the other? 

Anna: Yeah, absolutely. So, fundraising or financing, getting money in the doors a little bit like 32 flavors. So, there’s a lot of ways to do it. And there’s not sort of a one size fits all option for companies. Yeah, we see companies that are lucky enough to raise capital, from non-dilutive grants. So, there are local grants and others that are national grants where the company is able to get money in the door, SBA loans, by not selling part of the company.

Trevor: And that’s what you mean by non-dilutive. 

Anna: Yeah. So non diluted, when I, when we say about those talking about grants or loans, things where someone doesn’t either purchase part of the company in equity round, or they’re not entitled by virtue of some sort of convertible note or something to eventually own part of the company.

So, you see that some, but for most of our clients that’s just not enough, because to get to the level of growth and scale they need, they’re going to be talking with angel investors or venture capitalists, about getting larger checks in the door and to enable them to ramp up that growth quickly, get a competitive edge and eventually get to sort of their next round.

And so, the ways that we see in our practice, most commonly that happens, I would guess sort of two categories. One would be what we call convertible securities. And by that, I mean, when an investor comes in and writes a check to the company, what they’re getting out of that sometimes you hear convertible notes and sometimes you hear the term staves, but those in the bucket of convertible securities means that an investor is purchasing an investment in the company that will eventually turn into stock if things go well. 

So again, thinking about a convertible notice a lot like a car loan, okay. So, we’re all familiar with debt. what makes it a little bit unique for companies that we work with is there’s this feature in it that’s convertible, meaning that when the company raises a future round, it will convert into equity. And then that note holder will be able to own part of the company, a slice of the pie. So, sort of bucket one convertible securities. 

Bucket two, which is when we do probably even more than that deals with selling equity in the company, selling common stock or preferred stock. we’re an investor comes in, writes a check and actually owns a slice of that pie. And investors, obviously, for companies, that’s a big deal because you’re giving away part of your baby, right? 

And so, part of our job as lawyers, as counselors to these companies is helping them work through which one of those avenues makes the most sense for them now. And for a lot of companies, if they are at a point where they need a couple hundred thousand dollars to get them to a really big contract or get them a big PO that they could sort of satisfy, debt or a convertible instrument may make a lot of sense for them, because once they have that money in the door, they may be able to use it, and then increase their value, which means at a later round, when they go to sell stock, they’ll have a higher valuation and sell less of their company, which is good for founders. 

Trevor: So, I want to ask a question here, cause you know, sometimes we hear about angel investments versus a venture capital investment, you know, for our listeners kind of what’s the difference between angel and VC or kind of those levels. How do you think about that?

Anna: Definitely. So, when we think about angels, we’re typically, there are different flavors of this as well, but most commonly it could be a sophisticated sort of wealthy, we call them accredited, investor, an individual or a couple of individuals that come together and pool their money together, but are writing checks to invest in companies.

 Those check sizes are typically not always smaller and angels may be equally open to sort of starting the process with convertible securities or with actually purchasing equity in the company. So, angels is, you can think of that way. Venture capitalist, which a lot of folks are familiar with, and have, you know, I guess both great and not so great reputations. I like to think the ones we work with and that our companies get checks from are pretty great. but VCs are sort of angels, but to a supersized degree. So, the check sizes are typically larger, you know, think about seven figures, as opposed to hundreds of thousands.

Those investors are typically wanting to write checks into companies in exchange for equity. So, you won’t see as many of those convertible securities with venture capitalists. 

Trevor: Okay. I think that’s helpful. And so, as you think about this, and you think about your role as the counsel for the company and the role of the business as you get into fundraising, where do you draw the line or the differentiator?

What are you doing for the company and what is the company have to do on its own to get this money in the door?

Anna: I hope we’re doing, doing some really good stuff to help them, right. And so, the way we do that again is we start with day one with our clients, thinking about what the last day looks like.

And again, for most of them, that’s, I’m going to go down a winding path and hopefully the end of the, sell it for a lot of money. And so, we start working with clients with that proactive approach in mind, so trying to get their corporate house in order so that as they go along that winding road and they have to raise capital, they are ready to do that. with this little hiccups, I mean, there always be bumps, but helping them get to that point with as little hurdle as they can. 

And so, in the fundraising process, one of the things that we come on board early and do in addition to sort of all the great cleanup and corporate housekeeping stuff that Justyn probably talked a little bit about. We help out with term sheets. And so, a term sheet is sort of the, how the party gets started with fundraising. And so, you can think of it as some people call it letters of intent, but it’s a summary of what this deal is going to look like. You know, is it going to be a stock deal? Is it going to be a convertible debt deal? If it’s going to be stocks what are those basic terms?

What’s the valuation? What rights are the people that are writing the checks going to get in the company? And sometimes, you know, one of the things we see from companies is that they come in and have already done part of that process has come in to hand you a term sheet and say, we’re ready to close on this. Like want to close in a week, right. 

And in reality, you know, there’s been a lot of value lost, sort of with not working not just with legal, but with advisors generally in that term sheet process, because that’s where you can start setting out what we call company favorable, or if you’re an investor side, investor favorable terms and fleshing out some of the things that could eventually make the deal less likely to actually close, right? And while it takes some time and some money to do that, well, what we find is that a well baked out and well thought out term sheet helps sort of the next phase of that, which is sort of drafting all those fun documents go a lot more smoothly and your deal is actually more likely to happen once you have an agreed upon term sheet.

Trevor: So, let me back you up there. So, you know, we’re talking about having a term sheet in hand, so we’ve got deals. That means we’ve already kind of met somebody who’s interested in the company. How do businesses kind of go about getting to that stage? You know, how do you identify these investors? Where do I find them? How do I vet those relationships, what do you see for clients? 

Anna: Yes. So, I think there’s probably, hodgepodge of ways people do it. some folks are lucky enough to be in an ecosystem like ours, where you know who’s doing the deals. You know, they see the publications that come out of who’s invested in what, who’s raised money, and they’re able to sort of source connections from that.

There’s also sort of publicly available documentation, like one of the resources we provide for our clients is we’re able to use a resource called Pitchbook, which for companies that are in certain industries, we can sort of intel, go backwards and figure out what investors are writing series A checks in those types of companies and see if anyone in the firms familiar with those. 

And I think that’s probably how good advisors, not just legal ones, work, is that they’re able to do a great job in their professional service area. So, at a bare minimum, do great lawyering, but above and beyond that also able to make good connections for the companies, introduce them to folks, give them feedback of, you know, we see this happen a lot.

So, for companies, they might do this process three to five times. For us, we’re going to do it as a firm, hundreds of times a year, right. And so there, there’s value sort of in having those folks who do this regularly as part of sort of their job help you so that you get the best deal for your job. 

Trevor: Okay, and so as a CEO or as a company, when do you recommend, they start thinking about their next raise or think about raising funds? I mean, obviously there’s got to be a point where it’s too late because you don’t have any money left. 

Anna: Yeah, that is a tough thing, right? I think that if a company that’s going to be a growth company is sort of doing this the right way, as they start out as best, they can, knowing that things are going to change and morph like all businesses do. But I think most of them have to start thinking about their capital resources pretty early on, because that’s going to guide things like how you grow your team. It’s going to guide how fast you can grow your technology. 

And if you talk to founders who have gone through the fundraising process, you know, there’s usually a very heavy, transactional period with us where there’s documents and diligence. Then there’s this check that comes in or checks, and that’s a really great period, but usually within a couple of months after that, depending on sort of how long they’ve expected that money to last them, you’ll find that they’re sort of back out there with investor updates and thinking about, we may need money in 12 months or 18 months.

And what’s that going to look like? Because it’s when you raise capital part of around, the strategy around, I think for our clients is trying to raise the right amount of money, which is pretty important. And by that, what I mean is that companies that are doing really well and have a great trajectory often, you know, they’re lucky enough to have folks really wanting to write indefinite amounts of money into them.

And so, they have to decide what’s the right amount to take, because if what you really need to get you to the next round and a higher valuation is $500,000 or a million dollars, you don’t really want to take 2 million at sort of this lower valuation, because you’re going to give up more of the company, which isn’t great for you as a founder.

That’s, we’re having those conversations with companies too, as we help guide them through term sheet. You know, you’ll see some times we’re raising up to $2 million and what they’d really want is somewhere around one and a half and giving themselves some flexibility. But those conversations start really early and it does take longer than people expect.

Not necessarily that the hot and heavy transactional part, you know, that is a can run like a well-oiled machine. Like, call it a month of sort of going through the process and getting to final documents, but the harder part of that, and the part that takes longer is what you’re talking about, which is getting to know investors, figuring out sort of when they write checks, what you need to show them getting early and often contact with them and sort of, getting a relationship going.

It’s very hard to go and meet investors for the first time when you want to check. And so having those relationships early on is really beneficial to our clients. 

Trevor: Yeah. I think that’s the critical point, at least that I’ve seen because I’m somewhat more tangential to this practice, but it’s just, the first time you talked to an investor is not, when you’re asking them to write a check, it’s really kind of as you’re starting the process and you want to be able to show these investors, that your business is on a certain trajectory and it’s going well.

So, you start that conversation months in advance, if not years in advance of when you’re going to actually ask somebody to write that check so that they have that opportunity to see the trajectory of your business and why they would want to invest in you. 

Anna: Yeah. And that’s super important too, is if you wait until you really need money to try to start those conversations, I think one of the risks in that is that you’re giving up as a company, some of your negotiating leverage, right?

Because you have to get the money in the door, and so maybe the valuation’s not what you would have hoped or would have wished to, or could have gotten if you had a little more time to go out and make more connections, right. And so early, earlier is better in terms of, of getting acquainted with, and meeting investors who can eventually write checks in your company.

And like you said, sort of repetitive contacts of, hey, this is going on with us. Can we put you in our investor update and let you know what’s going on? But the more times they sort of see you succeed and also sort of tell them what you’re going to do and do it, I think that builds credibility, which makes writing the ultimate check of bet easier.

Trevor: Yeah. I think that’s absolutely right. So, as you, as you think about working with investors, aside from the size of the check, you know, what are some of the issues that companies should be considering when they think about who to take funding from? 

Anna: Yeah. So, this is a pretty nice segue into another part of our practice, which is, is that, Hutchinson, since we were formed 25 years ago.

So, celebrating a big birthday this year, which is a pretty weird year to do that. But part of our practice now that the one of the growing pieces is actually working with investor side representation, and perhaps my personal practice that’s even more so true. And so, we work on the venture side for quite a few clients representing the investors, right.

Which is a little bit of a different hat. But it’s, it’s also for the firm than a good practice to get involved with because we get to see sort of both sides of this, of this equation a little bit more. And it’s nice too, to have a little bit of the investor leverage behind you as you negotiate things.

But with investors, you know, for companies, again, sometimes the best deal on the table is the only one that you have. And when that happens, you know, we try to assist and help get the best, most marketable terms, the norms as we can. but for others who have multiple term sheets on the table, and then one may be slightly higher evaluation, but they don’t want a board seat or, you know, there’s, they’re sort of trade-offs for that.

And we’re helping companies evaluate that, but there’s also the part of the sort of intangible calculus that goes on with those companies is figuring out, you know, what else, in addition to the check, am I getting from these investors? So, for instance, Investors who have had success in your industry, or investors who have worked really well with other investors who might be your next big check.

Those are sort of the intangibles that go beyond just, you know, I’m getting a seven figure check in from this investor, right? Sort of the forward-looking process of how can they also help the company addition to just writing that check. 

Trevor: Right, because in many of these cases, not only are they putting money into the company, but they’ll have some sort of an ongoing role in advising the company and potentially you talked about board seats. So, you know, this is somebody who’s going to have a long-term relationship with the company, potentially. 

Anna: It is, yes. It’s a little bit like dating, right? Because at the end of this, you know what happens typically again, going into the, we wrote a check to get stock or ownership. Those investors, even after the check, they’re now part of your company, and it’s going to be very hard, if at all possible, to sort of get them out of the company, absent sort of this equity thing that we’re hoping is going to be a great one.

And so, with that in mind, you know, you do want to have a good relationship with your investors and feel like they’re going to be value adds to the company so that as you go forward and perhaps, they are on your board, but at a minimum, you’re going to be dealing with them as you go out for things like stockholder approvals or providing information each year about the company’s budget or how you’re doing.

And so obviously we’d like for that to be a positive experience for the company, because especially when you’re sort of coming in with your first round, one of the conversations we have with companies as they’d raised their seed round, their A round, is that the terms you take and how you, how you phrase or how you sort of steer that deal.

So that’s the precedent for future deals. So, you give away a board seat and to give away certain rights. It’s quite likely that in future rounds they are going to stack on to that. And so, you try to, try to start out, like you can hold out with some of those things, but having great investor relationships early on really helps company because they will be the best sort of missionaries for the company as you go forward and grow, and the best advocates for getting additional checks or eventually selling the company. 

Trevor: I want to go back to something you said, cause you know, for some of our listeners who maybe have zero exposure to venture funding, let me say things like series seed or series A or series B, what is that? And what does that really mean? 

Anna: I really, really appreciate that. So, series seed, it’s funny. There’s not a 100% solid definition of what that is, but as, as sort of a lawyer and a person who does it as a practice, when I hear a series seed financing, I’m thinking that a company’s coming to us and telling us they’re going to raise their first or very early round of funding.

I would also probably expect the check size to be a little bit smaller. So it happens, but I would think that add terms of rights and preferences that the investors will be getting a little bit less because they typically go hand in hand with check size, right, the bigger checks tend to get the fulsome rights. And as you raise or smaller rounds, you know, be at friends and family or your first angel round, it’s called a seed round.

What’s going off in my head is those rights and preferences are probably going to be a little bit less than they would be in a venture round. 

Trevor: Okay. And so, when you say a smaller check, I mean, do you have a ballpark figure in mind? Like what is the typical series seed or friends and family round look like?

Anna: Really can depend, we’ve had companies that raised a hundred thousand dollars, right. And that was what they needed to sort of bridge them into their series A round. You know, they got that big contract by sort of deploying the a hundred thousand. but most commonly what you’ll find is sort of in the seed round got 250 to 1.5, maybe.

Um, and then with what we think of as true venture here, those are going to be seven figure deals. There’s again, variations on the theme, sort of in-between those, but yeah, helpful ranges. 

Trevor: Now in the, in those series, like A or B rounds, do we typically see like one VC writing a check, or is it like a group of people that come in and make that investment?

Anna: Depends. So, what you’re, what you’re kind of talking about is the idea of a lead investor in our world. And so, what that means is there’s somebody that’s coming in, that’s writing the biggest, usually the biggest check, but almost as importantly, for us, the lawyers, it means that that investor is going to typically be the one who has council, that we sort of work with and against to negotiate documents. 

And so, you do see that it’s not always that you’re sort of opposite negotiator is the biggest check. Most commonly it is, but you also find that in some, some situations there will be VCs who pair up nicely together, they will co-invest. Other times you’ll find there’s just one investor that’s filling up 90% of the round.

Right. And so, you can definitely sort of guide that from a client or company thought process behind that. You know, when you’re raising capital, there’s a real benefit to getting the largest checks you can from the smallest number of folks or the smallest number investors. And what I mean by that is that we talked about sort of people investing in the company and how life changes after fundraising.

And so, one of the things that companies will be dealing with is having a company that might’ve had five to 10 owners before. Now could have, you know, 20 or 30, depending on how many checks they got in the door, right. And so, their life from a sort of record-keeping, financial updating, answering to investors perspective is a little bit easier if that number can be smaller.

So having a lead investor helps them with that. It also helps sort of expedite other checks coming in the. When you have a lead investor, who’s willing to say, I’ll do this deal and fund seventy-five percent of it on these terms. So often once you get that first lead commitment, then the other sort of fall in line as well.

Trevor: Okay. I think that’s helpful. And it kind of segues into the next part of the conversation, because I feel like we’ve danced around it quite a bit, of these different terms that might be negotiated in a financing. So, I’ve heard you say valuation or kind of certain preferences that they might have with regard to their ownership. Can you talk a little bit about some of these considerations and what might get negotiated and a financing?

Anna: Absolutely. So, most of these come out, most but not all, come out sort of that term sheet stage. And so, you could think about the largest two buckets of rights, one being what we’ll call sort of economic or financial rights. So, things like valuation and by valuation, I’m meaning what’s the company worth today? sort of the price tag of it. And that is probably as you’d expect, one of the most heavily negotiated items and not from the lawyering perspective or from the company and the business perspective, because it’s extremely important, right.

Based on where that number falls, that sort of neatly develops into how much of the company the investors will own and how much of the founders will have left. And so that’s why that number is, is a very important. And so, for companies that are doing this, you know, when they negotiate, valuation, what we sort of see, because we get to see on the emails and we’re trying as best we can to give tips or ranges of what we see in the market generally.

But it is a very company specific type of evaluation, but, you know, you’ll see the founder saying we’ve got this amazing product or technology, nothing out there like it. we’ve got the best founders. And it’s almost a term of art for negotiation with company side valuation arguments or negotiations, because they’re arguing intangibles, you know, we’ve got the team in place to scale this. We’ve got something no one else is doing. 

On the other hand, the investors, who’ve done this before, you know, it’s a very data or numbers driven analysis, right? We’ve written checks into 10 companies like yours. Here’s the type of return we want to see. We’re going to back into what we need to invest at, what valuation we need this company to be at, so that we can get the return that we think your company will yield.

And so, you know, there is natural sort of disconnect between those. But honestly, most of the time it works out okay. Like, you know, I’m sure both sides come away with not feeling like they’ve completely won, but that’s one that there’s a lot of time spent on that before we actually get too much into the term sheet because if you can’t get that one together, you don’t really have a deal. 

Trevor: Is it correct to say that ultimately the market’s going to determine the valuation, because whoever’s willing to invest at a certain amount is ultimately going to decide what the valuation of the company is?

Anna: Yeah. Yeah, that that’s true. You know, I think that would probably one exception to that is that letting the market determine when it’s a third-party person or investor is a good idea.

That’s sort of when that stands true. We’ve had companies whose related family members wanted to buy the company at some great multiple of probably what an outside or third-party investor would. And what you find with those companies is they can’t pull together enough capital sort of at that valuation, whereas if they had let sort of a third-party angel or a VC firm lead those deals and actually price tag the company, you would probably have more traction of getting jacks in the door.

Trevor: Gotcha. So first economic decision is evaluation. 

Anna: Yep. And there’s going to be a bucket of other sort of financial rights that are negotiated. So again, one of the things, the investor, in addition to wanting to be a part of an amazing company they want to cash out of this and get a financial return.

And so, there are what we call liquidation preferences. And what I mean by that is when the company sold, there is an order of distribution or priority with how these proceeds get divvied out to the owners. And so, if it makes sense that the investors, even though the founder sort of put the blood, sweat and tears into developing the company, the investors, as part of coming in and writing their check into the company, will say we want to get paid out or have the right to be paid out, sort of in priority to you.

For example, if the company doesn’t yield the type of return, we think we want be able to get our money back before the founders get anything. Or if the company has a great exit, we will sort of change over into the same kind of stock that founders have and just share with our piece of the pie.

So that’s another big one is making sure that your investors coming to you with reasonable expectations around what that liquidation stack looks like and sort of going full circle back to a couple minutes ago. When the first rounds happening, getting a reasonable liquidation preference in place is super important because if you start out with a 2X, which I mean by that, you know, you get double your money back.

 If you start with something like that, you can almost assure yourself that in future rounds, you’re going to be looking at the same. No, one’s going to say, okay, just kidding. Let’s go back to just giving you a 1X, right. So that’s important in the beginning. 

Trevor: Okay. So, evaluation, liquidation preference. What else? 

Anna: They’re probably two of the larger ones on the economic side. The more fulsome set of negotiations really go around what we call protective or control rights. So, by that, I mean, the investors, when they’re writing checks into companies, they may come in and own 25% of the company. And so, if you think about normal voting, right majority rules, and that’s not super great for these folks who just wrote millions of dollars’ worth of checks.

And so, the way that those investors sort of protect their investment is by having special rights and preferences that let them vote on or block things they otherwise wouldn’t be able to just by owning their 25%. Examples of this would be, we talked about earlier the board seat. So often investors will as a part of their investment, make it contingent that at least one person from that round goes on to the company’s board.

And why that’s super important for the investors because that board of directors for a corporation is really the highest level of decision-making authority, right? So, they are the ones that approve future financings, or sales of the company, or issuing equity out folks. That all happens at a board level.

So that’s a pretty important right. From the founder’s perspective, that’s going to sort of change life for them, because usually before that first round it’s been founders or co-founders, or a mighty group of three, that sort of does these board approvals and moves the company forward, but there’s now you’re faced with sort of board meetings and, providing information to your investors and sort of being accountable to the investors for the checks that they wrote and the faith they put in the company.

So that’s usually an important control, right? We also see things like, we call them preemptive rights. So that means that when an investor comes in and they purchase 25% of the money, what they want from the company is the ability to maintain that ownership if the company raises another round.

And so, you hear them call them preemptive rights or rights to invest, but it means that in a future round they have the right, but not the obligation to participate on the same terms as your next investor and maintain their ownership level.

Trevor: So, they’ll kick in more money, but they have the right to kick in enough to keep them at that same level.

Anna: Yeah. And you know, and most companies are pretty open to that because if things, hopefully you’ve kind of picked well with your investors, but again, sort of thinking about where checks come from, you know, investors are at that point, a known quantity. Most companies like the investors, are willing to sort of re up their commitment. New investors to the company also look at that. If prior investor isn’t willing to write a check and we know that investor has the means to do so. Why? So that that’s, that’s an important one as well. 

Trevor: So, this may be off on a bit of a tangent, but you know, were previously talking about kind of board seats and the importance of kind of having board control.

I think, you know, we’ve all heard kind of horror stories, founders who built this up this company, and then all of a sudden find themselves essentially kicked out of the company or kicked out as their CEO position. Is there, you know, kind of losing some of that day-to-day control of the company. Do you see that often, do you, is that something that’s really created through movies and other things or, or is that a real risk and how do people protect themselves against that? 

Anna: So, I, I think it probably has been played up a bit in the movies, but it is a risk. And for folks who have put years of their life into starting and growing a company, even if that risk is a small one, it’s a really important one. And so there, there’s a few ways companies can sort of protect against this. one is who or what we just talked about, the board level control. So not a lot can meaningfully happen in a company without the board approving it. 

So, selling the company, changing out officers. So, when you think about CEOs or CTOs, they’re all appointed by the board. And so, board voting is most typically down sort of on a one person, one vote basis. So, if you and I are co-founders, we’re going to have to agree at a board level on everything, right. And so, if we can’t, we’re sort of stalemated. 

As you start to raise capital in that board size gets bigger, what you’ll see companies start to negotiate, and we try to help with this, is what’s a reasonable board composition for your seed round or for your A round, and what does that mean if we have a CEO seat versus common seat? And so there, there’s a decent amount of effort, sort of at the term sheet stage again, put into how does that board structure look?

Um, because if you can, if a founder can maintain for as long as possible, control of that board. So majority control between that founder and his, or her, friendly colleagues or co-founders, they stand a longer chance of being able to hold control of their positions and not have a Facebook like problem pop up. So that’s sort of the board level. 

The other sort of mechanism that happens for control of the company is around the stockholders. And so, you know, tying back end of what we were just talking about, the control rights investors want. Typically, because their investment percentage is low, so they don’t own a majority of the company, they will have what we call protective provisions. So, if you think of those as bells and whistles, that investors get, where they have blocking rights, they wouldn’t otherwise have. And so, this comes across in the transaction documents. We work on as being a thou shalt, not do these 14 things without having the preferred stock holders approve them.

And it’s, you know, it’s higher-level things like selling the company or changing the charter, but they can also be pretty granular things like you won’t raise a debt round, in excess of a hundred thousand, without us, you want issue these stock awards without this vesting schedule, unless we approve it.

So, depending on how many of those appear you start to get into sort of granular control of your investors. When rounds are raised or at the stockholder level, the more control or more ownership percentages given away, the more likely you start getting into those types of scenarios where you have to look out for is the common stock or the founders. Are they protected in doing this round?

Trevor: Yeah. And are there other things, or other deal points where founders can protect themselves or what they should be focused on kind of at that term sheet negotiate? 

Anna: Yeah. Yeah. There, there definitely are. So aside from board, which we’ve talked about. There are also things like founder vesting. Sometimes you’ll see what founder investing is it deals with how, how a founder owns its stock and whether or not that’s owned 100% as of today, or if it, a founder owns, you know, over the next four years, it’s vesting monthly. And so, what you’ll see sometimes at a deal round is if a company hasn’t taken care of this founder vesting thing, which is one of the things we talk about early on with companies, if they haven’t done that often investors will come in and say, now I’m want to write you a check, Trevor, really like your company.

I’m going to need you to vest your stock. Vest half of it to make sure you’re staying involved with this company for the next three years. And when you, when you see things like that, there are, you know, basic tips, things like, oh, well, if I get ousted without cause I want to have that accelerate. Or if I leave, because with good reason, I want that to accelerate. There are some things that we talked to companies about when we start seeing founder related provisions, popping up about how to best sort of protect themselves in that equation as well. 

Trevor: Okay. And are there certain issues or areas that you see founders who talk to you being overly concerned about, but that you see as being in the long run not as big of an issue as, as they might think?

Anna: We’re lucky enough that a lot of the companies we work with the founders have either been involved with other companies or they have friends who have led companies. And so, some of the horror stories, or some of the myths they’re worried about have, have worked themselves out. The day-to-day operations of a company probably before and after financing.

I, we hear a lot of times that, you know, at closing now it’s just going to be totally different. And some of, some of their world does change, right. Again, board meetings look different, your cap table is a lot different. You’re now using Carta because got to manage all these securities that went out. But the operational part of it, the running of their business feels a lot the same the day after is due the day before.

And so sometimes they tell us that’s a little bit of a letdown, right? You got the millions of dollars in the door and like the next day it feels kind of the same. So, I think we’ve been fortunate to see that a lot of the things as we work through term sheets and we’re negotiating some of the smallest provisions the longest, those don’t actually come to amount to anything the founder is actually worried about in reality. 

Trevor: And we all have that problem, millions of dollars in the door, but it still feels like we’re just running the business the way it was the day before. so we touched on this a little bit earlier, but you kind of talked about when, when should a company look to involve their counsel kind of in this process?

Anna: Yeah, so, so I, I view the process as being, again, a fairly fluid and a pretty long one that starts well before term sheets are on the table. When companies, the fundraising process and sort of being ready for that starts when the company is formed, right.

Did you get your stock out correctly are there agreements around that? Did you protect your IP? And so, while those aren’t neatly kind of going into a term sheet, they are all things that as part of a deal you’re going to be looked at, we call that process diligence. So, whether we’re on the investor side or company side, when the check size starts to come in, usually again, bigger checks mean more diligence.

 But as part of that, they’re going to be looking to see those things were done correctly, right. And so, taking care of those when you’re not sort of in the heat of the financing is a really good idea. And so, I, I tend to tell folks that involving trusted advisors, as early on in the process as possible, you know, that not, not because our law firm wants to charge hourly clients to sort of gut them, but we are able to help clients proactively prepare and actually save them money as a part of this process. 

I’d also say that, you know, at the term sheet stage, there’s real reason to involve your council. So even though there are forms available for this, you can find seriesseed.com term sheets that are available online, or NVCA forms you can talk about, and they give you an outline of how these deals look.

But even with those types of forms, there’s always like things you could pick within ranges of reasonable or things that maybe are a little more company friendly than investor-friendly or vice versa. And so having trusted advisors or lawyers sort of involved with that, who can give you ranges of reasonable.

If you’re doing a convertible note round, what is normal interest rate, or how long should I be thinking about for this maturity date? Those types of things that, again, lawyers that do this, on a daily basis are going to be equipped to give you good feedback about what the market looks like so that you’re giving your investors or talking to them in a way that makes you sound pretty credible.

Trevor: Yeah. And coming back to the diligence side of things, I think, you know, one comment I wanted to make too is, you know, I think it expresses the importance of working with a, you know, a venture focused firm because, you know, as I think about my practice and IP protection or contract and licensing, You know, as we do those kinds of day to day operational side of things for the company, we have in the back of our mind that your goal as a company is eventually to take on funding or your goal as a company is eventually to take on an exit.

How do we structure this agreement so that you’re best suited to show value to future investors? How do you protect your IP now so that you can, again, demonstrate that value to investors or to a potential acquire? And I think that, you know, again is a value of working with somebody who’s kind of in this space and working with it on a daily basis is that we’re already thinking about that, but for you get to the point, where are you taking on money?

Anna: Yeah, because it can and can also sort of not only possibly blow up your deal, but can make your deal more expensive and take a lot more time. And so, by that, I mean, folks like you who work in parts of our practice, that deal with contracts or really important licensing transactions. You know how those things play with financings or change of control transactions really matter.

And so, setting those up in a way in the beginning so that the company has as much flexibility as possible to grow, raise the capital it needs, and eventually make the sell decision it wants to make, is really important because there’s nothing that’s a little bit more gut-wrenching than getting knee deep into an M and A transaction and realizing that there are these third-party prohibitions on change of control transactions.

And it’s hard, it’s harder and sometimes more expensive to have to go fix those when something really good is happening for the company. because it can raise sort of the what’s in it for me, type of response from folks when we’re chasing down invention’s assignments or things like that at a financing, because it’s a cue to folks that things are going well.

Trevor: Yeah, it’s better to have those conversations early. I did want to kind of touch on one of your points. You talk about kind of the costs and some of the things that can drive up the cost for financing. So, I guess for our listeners who are worried about like, why do I want to take on all this money and financing, and then it’d be so costly to have lawyers involved with it. I mean, how can counsel kind of reduce those costs or make it a smoother process?

Anna: Yeah. Yeah. So, so I think I hear you on that. First of all, I would say that working with firms who do this again is going to add in quite a bit of efficiencies from a cost and timing perspective, then ones who are sort of moonlighting into helping a company raise capital.

Um, I’d also say that again, firms like ours in terms of, of the, the overall deal, where we may be spending time actually helps companies come out in a much better spot than they would have been in. So, sort of the extra few hours spent negotiating a term may result in lots and lots more proceeds being payable out to the company. Which is what we want ultimately.

 they’re also ways that our industry, and we’re excited about it as a law firm, but like a lot of industries, we’re starting to see more technology coming into law. I mean, there’s a whole law tech industry. And as part of that, you’ll start seeing more crowdsource documents for sort of consolidating points on where these, where companies or where lawyers can start with financing documents that are agreed upon starting points, right? 

And that’s had the added benefit over the last five to 10 years of driving deal costs down. And most folks sort of think that’s bad for law firms. I think our law firms is a good thing, right? Because we want those companies to be able to get as much money into their pocket as possible, right. So that they can get to the end of this race successfully.

And so, when, whether you’re doing a series seed financing, you know, they’re starting point seriesseed.com. So, if your lawyers are working on deals, I would talk to them about those starting points. Be it series seed that come, or what we refer to as NVCA, which is the National Venture Capital Association documents.

You know, it’s funny. The other thing I would tell you about deal cost is depending on what type of financing you’re doing, deal costs can really range, right? And we’re sensitive to that as a firm because you know, whether you’re raising a million dollars on the sort of NVCA form, put your hundreds of pages of documents over seven to nine different things we put together. Whether you’re raising 1 million or 100 million, the documents are kind of the same, right. And so, we, we try to really be mindful of costs for companies. 

But using those starting points, I think helps lawyers when you’re getting those inbound the deal, you can sort of see what, what’s other law firm change, what are they trying to get into this deal? That’s not sort of market norm, and you can talk about those things rather than, yeah, make sure your client or stands the rest of the document, but here’s the, you know, the skeletons are probably going to be and what the changes are, and figuring out sort of where in the ranges of reasonable, they picked the different options. 

Trevor: Well, and I feel like also there’s a certain amount that you can control with you and your counsel, but there’s always going to be the opposing counsel on the other side of the deal as well, and really their experience and their familiarity with what are market terms or what are, what’s normal in the industry can directly impact your costs as well.

Anna: That’s what makes, you know, companies come in, they say what’s it going to cost to raise this A round or this B round. Depending on sort of who they’re negotiating, who the investors are, you can make some educated guesses about what council might be like on the other side, but it is kind of unknown. And so, we can often, again, we do this abed.

We can say, here’s what we expect this to look like in terms of us producing a first set of documents, and here’s what we expect that to cost. A little bit of unknown in terms of what happens once they go out the door to the other side and how reasonable it’s going to be in terms of the other parties’ lawyers working back and forth with us. We hope for the best. 

Trevor: Hope for the best that’s right. We only can control what we control, right. So, I guess kind of throughout your career, do you have any sort of horror stories, kind of financings that have gone bad that destroyed a company or anything that really kind of stands out as far as the opposite of that, you know, financing that was really exciting for you to work on and that really kind of set the company on the right footing?

Anna: Luckily there’s not as many horror stories. I, and there are a lot of good ones and, and that’s, that’s a really good place to sort of set because you get invested as a lawyer with warning of these companies to get the funding and be able to grow and you get excited for them and were a part of that ride.

Some of them, they walked into our office three years ago with just an idea and, you know, fast forward a few years later, and they’re getting their seven figure checks and really growing and doing well. I have a client that comes in and anytime we talk, he always asks, you know, have you seen a financing that was quite like mine and I always respond its challenging.

And what made that particular deal challenging wasn’t, company’s technology was great. They’re doing amazing, but it was a round in which there were a ton of investors and that’s and no real, we talked about a lead earlier and that made that deal challenging because it was a lot of equal-ish checks, probably a lot of different investors. no one really to negotiate against, but a lot of people that had a lot of questions and it took a while.

And, you know, as a founder, time that I know he wanted to be spending kind of focused on growing the business, putting out fires later, the financing and providing sort of all these answers to folks took a lot of time, but lucky to say that they’re doing great. 

Trevor: That’s good. That’s good to know that that, that they pulled it through. But I do want to touch on that as well, because when a company goes through the financing, can you talk a little bit about timeline for like the negotiation, and kind of amount of, essentially capacity, the CEO has to focus on, on the fundraising and what is it going to take for them? 

Anna: Yeah, you know, I had the goal of coming in today was saying as many, like, it depends answers as possible. I felt like it was a very lawyerly way to approach it. 

Trevor: Just vouches the fact that you are a lawyer. 

Anna: I was waiting for the validation and there it is, but it does depend a little on timeline, roughly for things like convertible notes. Firms should have great starting points for those, you know, provided there’s a, a general knowledge of who’s going to be investing.

It might take a law firm in a week to sort of put that round together. It’s kind of fast, and the cost is sort of commiserate with that. Safe financings, most companies do those, while we love to work with them on them, they’re able to handle most of that, their own. but when you get into sort of the venture, the larger rounds where there’s some thicker checks are coming in, and those hundreds of pages of goodness, I was talking about. 

Those rounds, you know, roughly from signed term sheet to check in the door or check in the bank, wire in the bank is maybe around a month or so. And that’s if things kind of progressed normally as you’d expect, and again, thinking about your diligence is in pretty good shape and you can, we have some deals to happen sort of term sheet to close in a month. That’s a little more aggressive, but it does happen. 

Trevor: Okay. I think that’s helpful to get in the mindset is what am I expecting? Cause I think typically my experience with all things legal is it always takes longer than clients want it to, or that we expect it to.

Anna: Yeah. Companies are rightfully really excited about raising money, right? And they have often have big hires they’re waiting on as they get the checks in the door or folks who are going to join the team or things, they’re going to do that are really exciting with the money. And so having to wait to sort of put that in action and deploy those funds is, it’s frustrating. And I get that.

And often, you know, from our perspective, we’re lucky enough as a firm to have. A pretty solid transactional practice. We have a lot of folks working on these deals and for us, they are sort of what, what drives our firm. And sometimes with larger, maybe more national firms, deal, we’ll see on the one to $10 million range or not, not the most interesting thing going on.

And so, it could take a little bit longer to get turnaround times on that. And so, there’s a little bit of coaching around patience, and sort of investor strategy on those communications so that they feel like you were interested, but not desperate to sort of move things forward.

Trevor: Very good. Well, I’m going to spring a question on you, cause I didn’t give this one to you in advance, but so we are the Founders Shares podcast.

And I typically ask all of our guests, you know, if you have one piece of advice, cause I’m typically talking to founders and ask them to share their one piece of advice that they would give to somebody kind of in their situation. So, I’m going to ask you that same question. If there was a piece of advice that you wanted to give to a startup company that’s looking to take on financing or somebody who’s considering maybe doing your type of position and your type of role. What advice would you give them?

Anna: I’ll answer the one on sort of the lawyer side of this first. I came out of law school a long time ago. Joined Hutch in 2008.

And from minute one sort of knew that this was a type of practice I enjoyed. And it’s, it’s transactional in nature, which means that there are periods of sort of intense involvement with clients where they raise capital or they sell the company. And there’s in between that there’s a sprinkle of really like just being involved with them and giving them general business advice. And that for me has really, I’ve, I’ve loved every minute of that. 

Um, and so folks who are thinking about this as a profession, I couldn’t have been happier with that type of decision. I tell you that not all deal sort of close, and that’s, that’s heartbreaking for everybody involved, but as a transactional practice, it’s a ton of fun, 

For clients, you know, I think it’s probably not too dissimilar to how they live their professional life or their personal lives in terms of surrounding themselves by good people, surround yourself with good advisors and people that are familiar with what you’re doing.

Whether that’s, you know, good accountants or good lawyers or just good business mentors, because I, I think they will be able to tell you about their mistakes and save you some time and you don’t have to make all of them yourselves. And also, along the way, save you some money as well. And that’s, that’s sort of, I keep referencing back to your initial podcast about sort of the startup mistakes.

I’d encourage folks to listen to those because there’s a reason why Justyn came on and said, here’s what we sort of see. It’s because it happens enough that it’s common themes, right? So, if you can have people to help you get through those, that having to make them yourself, good for you.

Trevor: That’s a great, great segue to the fact that, you know, we are the Founders Shares podcast. And if you do want to check out past episodes, that can be found pretty much anywhere you can find podcasts, but you can also find them at our website at hutchlaw.com/podcasts. Anna, is there any way that people who are interested in talking to you more about financing or anything else can get ahold of you?

Anna: Yeah, absolutely. So that website, you mentioned, hutchlaw.com com has my contact information also. I believe it’s a nice @annatharrington, which is very creative, but definitely gets the job done. So, I always welcome people love to get to know folks. and I’m definitely enjoying being able to see more people like you. And so, I’m always welcome people to reach out. 

Trevor: Very good. Well, I appreciate it so much. Thank you so much for coming on today has been so much fun and I loved it. Thank you. Take care. 

Full Episode Transcript

GIVEAWAY: Inspired by the Robbie Hardy episode where she shared the unbelievable story about how she used a magic 8-ball to help her decide whether or not to sell her company, we are giving away a Hutch 8-ball to anyone who writes a Founder Shares podcast review. All you need to do is write a review on Apple Podcasts or wherever you listen – and let us know by sending an email to podcast@hutchlaw.com.

Hosted by Trevor Schmidt, Founder Shares is brought to you by Hutchison PLLC, and is edited and produced by Earfluence.

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