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Save the Money for the Company: Standardizing VC Contracts

Published: March 15th, 2024
In a recent paper, Stanford’s Robert Bartlett finds that early-stage VC documents have become far more standardized since 2003 while capital structures have become more complex.

The development of model legal documents for companies backed by venture capital has been one of the great achievements in American corporate law in this century. In 2003, the National Venture Capital Association drafted a model term sheet and five related financing agreements for VC lawyers to use in launching companies.

Those documents now dominate VC practice, Robert Bartlett shows in his new article “Standardization and Innovation in Venture Capital Contracting: Evidence from Startup Company Charters.” The forms streamlined the legal work involved in early-stage startups and allowed for the evolution of more complex financing structures. The forms aren’t straightjackets but allow for customization on a number of key points.

Bartlett, a professor at Stanford Law School, based his paper on analysis of almost 5,000 charters issued in connection with a startup’s Series A financing between 2004 and 2022. At the start of that period, he found, fewer than 3% of charters used the NVCA’s model form; by the end, 85% did.

One big winner was Delaware, the jurisdiction of incorporation for 54% of the 2004 VC charters and 100% of the 2022 charters. Wilmington law firms have been richly rewarded for their work with the NVCA, since the model documents have helped the state retain its preeminence in American corporate law.

The law firms that dominate VC work also benefited — a group that includes Wilson Sonsini Goodrich & Rosati PC: Gunderson Dettmer Stough Villeneuve Franklin & Hachigian LLP; Cooley LLP; Fenwick & West LLP; Orrick, Herrington & Sutcliffe LLP; and Goodwin Procter LLP. By 2022, Bartlett writes, more than half of those firms “appear to have adopted a firmwide policy of using the NVCA model.”

They had strong incentive to do so, since VCs have long limited the amount of money their law firms could charge for drafting and negotiating documents. “For lawyers faced with these constraints, the risk of dealing with inexperienced counterparts or those insisting on unusual terms could thus translate into having to write off billable hours,” Bartlett writes, which gave repeat players strong incentive to promote standardization.

The law firms took years to adopt the forms, though, suggesting that they may initially have feared losing a key competitive advantage by giving up their own forms. Instead, Wilson Sonsini and its rivals have remained dominant in VC finance, suggesting that their clients value them more for the advice they provide than the paper they produce.

The explosion in VC financing over the past generation has allowed those law firms to retain their dominant position in VC while providing opportunities for new entrants, especially in places outside of Silicon Valley.

As VC documents have become standardized, the startup capital structures have become more complex thanks to the emergence of seed-round financing before companies raise a Series A round. Bartlett found that 86% of Series A charters in 2004 provided only for a single class of common stock and a single series of Series A preferred stock, but that description applied to only 5% of 2022 charters.

But 30% of the 2022 charters “had either 2 classes of common stock or 3 or more series of preferred stock,” Bartlett wrote. “The additional complexity arises almost entirely from multiple securities reflecting prior seed stage financing.”

The greater availability of seed financing is in turn a product of the massive increase in capital managed by VC firms, which rose from about $4 billion in 1980 to over $200 billion for virtually every year between 2000 and 2009. That money has also led to both an increase in the number of startups and the amount of time the successful ones have been able to stay private.

It’s also given founders more leverage. Bartlett cites one study that found that 37% of the Series A financing rounds raised in 2002 left VCs with control of the startup’s board of directors, a figure that had fallen to 10% by 2017.

Nevertheless, Bartlett found that dual-class common stock and founder preferred stock, both of which increase founder control, remained uncommon in early-stage companies. “Their annual incidence is never more than 5% and 8%, respectively,” he writes, and they occur even less often after 2016. Still, he adds, “It is plausible that these founder-friendly provisions are adopted in more mature firms.”

Law firms welcomed, or at least accepted, standardization in early-stage VC work, which is a “lower-margin, high-volume practice” relative to M&A and securities work, Bartlett writes. Firms likely wouldn’t be as accepting of standardization in more lucrative areas.

A parallel dynamic has likely happened in private equity, where the ever-rising number of transactions has forced lawyers to work more efficiently and, quite possibly, to use more standardized forms, and private equity sponsors haven’t imposed the fee pressure on their law firms that VC firms did.

As lawyers worry about how artificial intelligence may change the market for legal services, Bartlett’s paper suggests that greater standardization of documents doesn’t necessarily come at the expense of the lawyers who produce them.

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