Thanks to Walker Corporate Law Group, a boutique law firm specializing in the representation of entrepreneurs, for supporting Venture Hacks this month. This post is by Scott Edward Walker, the firm’s founder and CEO. If you like it, check out Scott’s blog and tweets @ScottEdWalker. – Nivi

It’s a new year — which means it’s time to make resolutions. Rather than write about my resolutions, I decided to put on my lawyer hat and advise entrepreneurs on what I think their New Year’s resolutions should be. During my 15-year career as a corporate lawyer (including nearly eight years at two major law firms in New York City), I have seen entrepreneurs make certain fundamental mistakes over and over again. So what better way to welcome in the new decade than to recommend the following resolutions to entrepreneurs…

Resolution 1: “I will create a competitive environment when I’m doing deals”

There is nothing that will give an entrepreneur more leverage in a negotiation than a competitive environment (or the perception of one). Every investment banker worth his salt understands this simple proposition. Not only does competition validate a firm’s interest, but also it appeals to the human nature of the individuals involved. Competitors can be played off each other and, as a result, the entrepreneur will be able to strike the best possible deal.

I learned this important lesson as a young corporate associate in New York City. As I discuss in my video post, Lessons Learned in the Trenches of Two Big NYC Law Firms, I recall having two M&A transactions on my plate: one was a divestiture — i.e., the sale of a division of a multinational corporation being auctioned by an investment bank; and the other was the sale of a private company to a competitor (with no i-bankers involved). In both deals, my firm was representing the sellers but, as we worked our way through the negotiation process of each deal, we ended-up with two completely different acquisition agreements with respect to the material terms.

In the auctioned deal, because the i-banker was able to play the prospective buyers off each other and create a competitive environment, the final agreement was extremely seller friendly and included broad materiality qualifications, a huge basket/deductible and a cap on seller’s liability of 10% of the purchase price. In the private-company transaction, however, there was only one prospective buyer — and the buyer’s principals knew that the seller was anxious to sell and thus were playing hardball. The deal terms ended-up being extremely buyer-friendly and included a large portion of the purchase price being escrowed and a cap on the seller’s liability equal to 100% of the purchase price.

The lesson learned is that you must create a competitive environment (or the perception of one) in order to have strong negotiating leverage. There is, however, one important caveat that entrepreneurs should keep in mind: this game must be played carefully and is better handled by someone with experience. The last thing an entrepreneur wants is to end up with is no deal at all.

Resolution 2: “I will leave my heart at home”

You have to think with your head, not with your heart — particularly when you’re doing deals. The best deal guys are masters at taking their emotions out of transactions and being extremely disciplined. They will just walk from a deal if they get out of their comfort zone (e.g., with respect to the price, risk profile, etc.), regardless of how much time and money they have spent.

On the other hand, most entrepreneurs become emotionally wedded to a particular transaction and are unable to maintain their objectivity as they move further along the deal process. They get all excited as soon as someone waves some money at them and allow themselves to get drawn into the money guy’s web. It is critical that entrepreneurs understand this dynamic. Entrepreneurs will generally be negotiating with guys on the other side of the table who are far more deal savvy than they are – venture capitalists, private equity guys, etc. – guys who are masters at playing on their emotions.

This is why it is so important for entrepreneurs to establish a game plan (i.e., dealbreakers) before the negotiating process begins and to have the discipline to stick to the plan and be willing to walk, if necessary. If an entrepreneur is seeking venture capital financing, he should sit down with his transaction team before reaching out to the VC’s to establish his dealbreakers with respect to key terms, such as valuation, the liquidation preference, board composition, etc. The same approach should be followed if he’s interested in selling his company: What’s the lowest purchase price you’ll accept? What’s the highest cap on liability you’ll agree to? Will you agree to escrow part of the purchase price? If so, how much and for how long? Once you establish the dealbreakers early on, you can take your heart out of the equation and think with your head.

Resolution 3: “I will work my balls off”

This is the advice a senior partner gave me when I was a young corporate associate at a major New York City law firm: “If you want to be a great lawyer, you have to work your balls off and make practicing the law the number one priority in your life.” He explained that this means everything else in your life has to be pushed aside, and you need to “work, work, work.” And when you’re not working, he added, you need to be reading treatises and articles discussing the deals you’re working on to get a deeper understanding of the significant issues. When I explained to him that, after three months, I had been working nearly every weekend and that my girlfriend was ready to leave me, he told me that I need to get a new girlfriend.

I received similar advice from Harry Hopman, my old tennis coach (and the winningest coach in Davis Cup history), when I was playing tennis in the minor leagues after college. He preached to me that: “It all comes down to one word — desire. How badly do you want it? How much are you willing to sacrifice?” And he was right. When I was traveling and playing tournaments in Europe and South America, I noticed that the best tennis players were generally the hardest working; the qualifiers were the ones going out drinking every night, not the top seeds. Sure there were exceptions — like John McEnroe — but the exceptions were rare.

I have seen this same pattern during my legal career: the most successful clients tend to be the hardest working. The private equity guys and hedge fund guys I represented in New York City were animals; working around the clock and cranking out deal after deal. I attribute a lot of their success to just plain hard work. In 2005, I moved out here to California to help entrepreneurs, and it’s been a mixed bag in terms of the work habits that I’ve seen. Some of my clients are intense and put in the long hours; others, however, are just dreamers — and they are the ones who struggle. In short, there are no shortcuts to success.

Resolution 4: “I will not let my investors screw me”

Here’s the advice I give all my clients to avoid getting screwed by their investors: do your due diligence prior to accepting any money. The number one mistake I have seen entrepreneurs make in any deal is the failure to investigate the guys on the other side of the table. Remember, you will, in effect, be married to your investors for a number of years. Accordingly, entrepreneurs must do what any bride or groom does prior to tying the knot — date for a while and, of course, meet the family.

What does this mean in practical terms? It means surfing the web and learning everything you can about the particular firm making the investment and, more importantly, the particular individuals with whom you are dealing (and who, presumably, will be sitting on your board for a number of years); it means breaking bread and having a couple of beers with the potential investors; and it means getting references and talking to other entrepreneurs and founders who have done deals with them. Issues to address include: How have they treated their other portfolio companies? Are they good guys or jerks? Can they be counted-on and trusted? Do they share your vision for the venture? Will they add significant value (e.g., through contacts, domain expertise, etc.)?

There is an outstanding video discussion on Mixergy.com between Brandon Watson, a smart entrepreneur (currently at Microsoft), and Andrew Warner, the founder of Mixergy, as to what could happen if you don’t adequately diligence your investors. Brandon is extremely candid and discusses how he got “bullied” by his board. Moreover, he expressly notes in the comments to that post that, “the diligence factor was that I knew them, but had never taken money from them. It’s hard to know how people are going to react when they are at risk of losing money because of something you are directly responsible for until you are actually at that point.”

Resolution 5: “I will retain a strong, experienced lawyer to watch my back”

This is obviously a bit self-serving, but every entrepreneur needs a strong, experienced lawyer to watch his back. There is just too much at stake for entrepreneurs to be (1) using sites like LegalZoom, (2) pulling forms off the web and trying to play lawyer, or (3) retaining the cheapest lawyer to save money. And as the Madoff affair and other recent high-profile cases demonstrate, there are a lot of unscrupulous characters out there trying to take advantage of unsophisticated entrepreneurs.

There are also more subtle potential problems entrepreneurs need to be protected from, including the inherent conflict of interest that certain service providers have. For example, entrepreneurs need to be careful with investment bankers, who generally only get paid if a particular deal closes. Indeed, a middle-market i-banker’s entire year can be made or broken based on whether or not he can close one or two deals.

Unfortunately, I experienced this issue first-hand shortly after moving to California when I got pulled onto an M&A deal in which an i-banker stuck his finger in my chest and warned, “We’re going to get this deal done despite you fucking lawyers.” He then later complained to the managing partner (who had the client relationship) that I was blowing up the deal because I had retained special environmental counsel from my old NYC law firm and we were pushing too hard on the environmental indemnity. Good work by the i-banker (and cheers to my former managing partner) for getting the deal closed by watering down the environmental indemnity: less than six months later our client’s company was indicted for environmental problems that it inherited as part of the acquisition.

The bottom line is that a strong, experienced corporate lawyer will sober the entrepreneur and lay out all of the significant legal risks in a particular transaction; he will then push hard to negotiate reasonable protections. If the deal sours and lawsuits are filed, well-drafted documents with appropriate protections become a kind of insurance policy to the entrepreneur.

If you like this post, check out Scott’s blog and tweets @ScottEdWalker. If you want an intro to Scott, send me an email. I’ll put you in touch if there’s a fit. Finally, contact me if you’re interested in supporting Venture Hacks. Thanks. – Nivi

Topics Closing · Entrepreneurs · Lawyers · Psychology · Reverse Diligence · Sponsor

11 comments · Show

  • Schwabe

    Tremendous stuff for aspiring entrepreneurs. I love Walker’s writing style. He’s like a bucket of water in the face; it really gets your attention.

  • 5 New Year’s resolutions for closing deals in 2010 – Venture Hacks « LJR Enterprises

    [...] January 6, 2010 at 6:59 pm (Uncategorized) This is obviously a bit self-serving, but every entrepreneur needs a strong, experienced lawyer to watch his back. There is just too much at stake for entrepreneurs to be (1) using sites like LegalZoom, (2) pulling forms off the web and trying to play lawyer, or (3) retaining the cheapest lawyer to save money. via venturehacks.com [...]

  • Anonymous

    I love Venture Hacks, and I continuously read and heed the advice you offer. But occasionally, something just misses the mark.

    The advice is great, but how about we get a little real for a second here. How is a start-up company — fighting for every penny that drops — supposed to be able to afford “a great corporate lawyer” on retainer?

    I’m not talking companies when they’re ready to close deals, or go public, or raise capital. I’m talking about the 80% of the gruntwork that goes on before all that. Incorporation, contracts, patents, trademarks, IP protection, Terms of Service, Privacy Policies, and so on.

    Seriously, the advice is great. But HOW? How can a company in its true stage of garage venture heed that advice? My experience has shown me that it simply can’t, ergo the LegalZooms, and the cheap lawyers, and all that. I know in our case, if we had spent what money we had on lawyers, our product would have never been built, never seen the light of day at all.

    I understand where this advice is coming from, but sometimes I wonder if some of your guys have all made it so far up the venture ladder they’ve forgotten what the dirty trenches look like. Its brutal down here guys, brutal!

    • Nivi

      Good question.

      A good lawyer can help you identify the high-risk stuff that must get done immediately and the low-risk stuff that can wait. At the top of the list is incorporation and founder agreements. A lot of other things can wait.

      And an inspirational entrepreneur can get a lawyer to defer fees.

      It also helps to be in a startup hub, so your friends can introduce you to lawyers and lend their social proof to your company.

      • Giff

        I’d add to Nivi’s response that a law firm that is truly startup-friendly and startup-experienced not only might defer fees until a funding event (although you still need to watch hours carefully because you’ll need the cash later too), but they will have very good templates in place that work pretty well out of the box. At my last startup, we worked with a law firm and with the kind of solo practitioner Scott refers to below — depending on task.

        On saving money, when it comes to business deals, work out all the business terms first in an LOI, and edit your contract template yourself before you involve a lawyer. Educate yourself so you can negotiate NDAs. With seed rounds, it seems like enlightened angel investors are gravitating towards a few standard templates which helps control costs (although there’s still a lot of blanks to fill in). When it comes to selling your company, you *really* want to have a solid attorney at your back.

    • scott edward walker

      Thanks for your comment, albeit anonymous. My post is about doing deals; and tip #5 is to retain a “strong, experienced corporate lawyer” to watch your back. I never suggested that a startup should be hiring “a great corporate lawyer on retainer” to handle “gruntwork.” Indeed, my advice with respect to “gruntwork” is to find a good, reasonably-priced lawyer — and there are plenty of them out there. If you would like, you can give me a call at 310-859-7177, and I am happy to discuss with you how my firm can help you (or I can recommend attorneys for you). Thanks again.

    • Anonymous

      Hi, it’s the previous anonymous, back.

      I’d love to comment with my name, but seeing as though my opinions do not represent those of my company, I err on the cautious side.

      I appreciate the responses and the insight into opportunities like getting good lawyers to defer fees, etc. Thanks to Scott for his info too.