Trust the Words, Check the Numbers
Your lawyers are there for a reason, but don’t leave it to them to ensure that the calculations on the cap table are correct.
I was lucky that when I switched firms (for the first time, earlier in my career) that the general partner who I newly worked for truly did empower me to lead my first investment on my own soon thereafter. He provided the political air cover internally and offered me the opportunity to play the lead role in negotiating the term sheet directly with the entrepreneur. However, even though our internal counsel largely helped drive the process of drafting definitive documents and closing the investment once the term sheet was signed, this boss threatened that I must understand every single word of those lengthy agreements. After all, I was ultimately responsible for what our firm was signing.
What? Multiple docs comprising hundreds of pages with acronym soup of SPA, IRA, ROFR, etc. seemed completely overwhelming to me. I didn’t go to law school for a reason! And now I’m supposed to comprehend everything?
Over time I’ve come to understand it’s not as complicated as I first perceived it. All of these documents are based on forms, and only a subset of the terms and language are really negotiated. The rest is just lawyers nit-picking with each other because that’s what they do. You just have to learn where to really pay attention, a skill which is largely acquired through experience over many many investments. (For example, as a seed investor, I almost immediately turn to check the language around preemptive rights for the next round of financing!)
The good news is that it’s the job of your counsel, whether it’s an in-house resource or a third-party firm, to work on your behalf and interest in finalizing these documents. In fact, they’re legally and ethically required to do so. The challenge as a young VC is to discern when your lawyer is offering legal advice from when they’re venturing into a business realm, and having the fortitude to go against their recommendation when it’s in the best business interest to do so. (Good counsel will be able to communicate the separation between the two.) All of that being said, you can trust the words on the page which your lawyers put there.
However, there’s one aspect of the closing process that you shouldn’t completely leave in the lawyers’ hands: creating the pro-forma cap table. Lawyers go to law school because they’re good with words, not numbers. And whether you personally are drafting the cap table, an analyst on your team, your counsel’s team, or someone on the other side of the table, I implore you to double-check the calculations again personally! I can’t tell you how many mistakes I’ve seen over the years in the cap table figures. Plus, now with multiple seed rounds, SAFE conversions, option pool refreshes, etc., it’s most often not completely straightforward… leaving even more room for error. And the numbers typically shift even towards the end of the process as the round size is revised with additional syndicate partners or other tweaks to the docs. Check those figures again!
More than once in my career, after closing the cap table had to be reopened and revised because there was some major mistake made. Nobody is happy when that happens, especially the parties who as a result own less than they thought. After all, there’s no such thing as a cap table where ownership adds up to more than 100%. If one party’s ownership goes up, somebody else’s must go down. And those situations where I’m referencing are only the cases where the mistake is so egregious that it’s completely unfair not to make the modification.
Don’t let a big error or a even small mistake happen on your watch. As your investments are approaching a close, let the lawyers spend time in Word, but you should spend the time in Excel.