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Entrepreneurs need to learn some law

From cdixon.org

I recently wrote a post where I said entrepreneurs need to understand term sheets on their own, without the assistance of lawyers.  I got quite a bit of criticism for this, e.g.

@rafer Never ever sign a term sheet without your atty’s review. sry but thats crazy talk @cdixon http://bit.ly/UOgiC myreblog http://bit.ly/cJ9d0

I’ll agree that entrepreneurs, especially first timers, should have lawyers review everything they sign.  But I stand behind my main point:  you can’t outsource the understanding of key financing and other legal documents to lawyers.

Here’s just one of many examples of why.   A company I know was recently confronted with the following trade off.  Get a higher valuation with full ratchet anti-dilution or a lower valuation with weighted average anti-dilution.   The only way to assess this trade off is to understand what these terms mean and try to compute the expected value of the two offers.   In this particular case what matters is the likelihood of a future down round.  This is a business judgment, not a legal one, and the people best able to make it are business people.

You also need to consider your personal utility function.  For example, as a founder, I don’t care very much about anti-dilution provisions because I figure in the cases where it matters I will already have been fired and my equity crammed down.

My point is you can’t leave these judgements to lawyers.   They don’t have the expertise to make these expected value calculations nor do they understand how various scenarios affect the founders personally.

Another common mistake entrepreneurs make is let their lawyers argue over terms that don’t matter.  This puts deals at risk and costs money.  You need to understand what they are arguing over to decide when it matters and when it doesn’t.

You learn about these legal issues from experience, by talking to lawyers, by talking to experienced advisors, and by reading blogs and books (every entrepreneur should read The Entrepreneur’s Guide to Business Law).

About Nathan Kaiser

Comments

  1. YC says:

    +1. Entrepreneurs needs to have general understandings of all aspects of their businesses in order to ensure things can work properly.

    It is true the entrepreneur often will be better off hiring specialists for the job, but how would she be able competently evaluate the candidates if she cannot understand a thing of what they talk about?

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