What if you can only change one term?

WHAT DO YOU DO when your client, who likes to self-lawyer, calls you and asks you what term you would change if you could only change one provision in a funding term sheet?
I will share my answer with you with one caveat. I do not think there is one best answer to the question especially the way it was posed to me. But, sometimes, you are called upon to make a call when there is no best answer.

First, some background. I knew this client well and had worked with him for years. We had negotiated his way out of a prior business together and he had a fast growing company that needed cash badly. He loved to do his own lawyering and we knew each other well enough to kid about how he was just deferring my services until it was time to clean up his messes. And, he was very bright and good at negotiating.

When he called with his question he had been searching for money for a while. A prominent West Coast venture firm was visiting as part of their diligence and had written him a big check he could cash as an advance against their full funding if and when he signed their term sheet. They were leaving in an hour and he wanted the advance money now. He would not let me see the term sheet, saying it was your typical series A convertible stock deal with the right to have a director and some class vetoes.

“How long is it,” I asked. “Just a couple of pages,” he answered.

So, back to the original question. If you cannot even read the term sheet and have to give an opinion about what one thing to negotiate – the client thought correctly that if he changed just one term they would sign it on the spot and release his advance check – what would you change? The valuation? The veto rights? The preferred preferences? The director rights? Or, some other restrictive term common to series A investments?

Well I went a different direction. Remember, it needed to be a potentially impactful change that the business people on the scene would feel like they could change without risk. My answer? The attorney fee reimbursement obligation. I said cap the amount you have to reimburse their lawyers at a low number.

An hour later I received a copy of his signed term sheet. It was short on details with only one written change initialed by both parties. The amount the company had to reimburse the investor’s lawyer for was reduced from $30,000 to $5,000.

And then the fun began.

A week later I got a call from a partner in the big Silicon Valley law firm representing the venture firm. He was annoyed by the attorney’s fee limitation and admitted he did not quite know what to do.

"It’s not enough for us to staff this properly," he said, "or even to draft the documents."

He asked if I would draft the documents (always an advantage) and said he will send me a copy of a recent funding they did for the same client with a company they bought controlling interest in. He asked me to use his documents as a form.

I agreed. What I heard was that his form would not have the normal vetoes and board protections that restrict management freedom. You do not need those when you buy a controlling interest. I also heard that he was not going to think hard or critically about what we sent him if it did not look too different from his form.

When I got his form, I talked with my client. The form was what I expected. It was much lighter on restrictions that a normal minority interest series A investment. So we agreed to an approach that would have me stick closely to the form adding in only what was specifically required by the sketchy term sheet.

Once this was done we sent the agreement with a redline against his form to the lawyer in Silicon Valley. As we guessed, he gave it only a cursory review and we closed quickly.

The client wound up with great terms in his series A that continued to flow through four more rounds of funding. On more than one occasion new investors, who felt constrained by the terms of the first round which are usually the most restrictive, noted to me that they could not believe the terms we got for the company.

And the ultimate end? The prominent West Coast venture fund that provided the series A funding got it right notwithstanding the light protections in their series A stock. The entrepreneur delivered a gigantic exit after several years that provided the venture fund with its highest return in its portfolio.

Would I give the same answer again? I do not know. It would depend on the circumstances.