Venture capital firms use an option model: by taking control, they lock up assets early and cheaply and then, over time, play winners and discard losers. The aim of a 10-to-1 return leaves no slack for losers.
Law firms closely tied to VCs also use an option model. They defer fees until first funding in exchange for equity, and they write off the fees – and the client – if funding fails. A lock-up occurs if a deferred-fee company gets stuck with poor first-round terms and a control shift. The pressure to fund is great, and it is hard to shop a deal where fees come off the top.
With a control shift, founders are at the mercy of portfolio reviews. Come what may, it is certain that portfolio goals, not founder hopes, will be the basis for it. And the law firm will follow the lead of a VC-controlled board.
Early-stage lock-ups may suit a few A-list or capital-intensive companies that either must or should labor under an early VC lock. Others ought to be wary. Founders and VCs can and do work together, but one or the other will gain relative advantage depending on when control shifts.
If I own a remote lot in the country, I may profit by giving a developer an early lock on my property, but I will profit more if I wait until developers flock to me after values have risen in a land boom. The key is when and how I give up control.
Likewise, when you as a founder deal with VCs, patience and positioning are key. You gain leverage, and get better terms, the more you build value before yielding control. Watch out for “easy finance” terms that increase risk of early loss of control – they can bite.
Our Silicon Valley lawyers can help you avoid early VC lock-ups. To build a company right, it is critical to hire a law firm that does things right. What you don’t need are the strings. We do straight lawyering that lets you keep funding options intact. We can help with VC funding as well – when the time is right.