The Dangers of Transactional Precedent – The Times They Are-A-Changing
By: Lori Smith
The other day I had a client ask me to review some form documents that another party wanted to use in connection with the client’s website. The basis of the request was that he thought I had prepared, or at least reviewed, these documents when they were originally created – over 10 years ago (coincidentally I had reviewed them, but had been somewhat critical, in part, at that time as off-market). This got me thinking about how many companies (and lawyers) rely on templates or precedential deal documents collected over many years, without thinking about the specific facts and circumstances of the deal they are doing or the passage of time and how that might implicate the need for updates and revisions.
Most transactional documents are not just forms. They are written manifestations of a business deal between, or among, two or more parties. While there is value in not reinventing the wheel every time, what works in one situation may or may not work in another situation. Also, a new set of eyes may see things that the original draftsperson did not or may bring a new viewpoint to how to address an issue. In addition to thinking about conforming a document’s business terms, such as price, term of the contract and indemnification to fit the business deal, parties to an agreement also need to consider how the market has changed over time for specific types of deals as well as changes in the law.
This was particularly relevant to the question asked by this client who was looking at investment-related documents in the venture capital space. The dynamics between early-stage investors and founders depends in large part on the relative leverage the parties have in the marketplace. A “hot” company will generally demand more founder-friendly terms and that has been the case for all of the 35 years I have been practicing. But the nature of the negotiations and the bid and ask has changed. In this space 10 to 15 years ago, things like SAFEs and KISS documents were unheard of, and even having open source series seed and NVCA documents were relatively new. Back in the early 2000s (perhaps driven, in part, by the state of the markets) participating preferred with accruing compounding dividends and even redemption rights were pretty common even for small angel investment rounds. However, this market has matured and seed and angel investment rounds look much different than they did 10+ years ago.
Part of this is that Series A rounds have moved upstream to larger size rounds at higher valuations. Both sides of the table have recognized that they need a more realistic approach to efficiently negotiating and closing a small seed investment round, as well as not setting precedents that will harm the company long term. Another part is that the documents themselves have evolved from NVCA, series seed and SAFE version 1.0 to versions that the market has adapted over time to address concerns raised by various constituencies. In this case, I don’t work with the particular investor who is using the documents I was asked to review, but I would guess that since the documents are far off-market it is probably impacting the quality of the deals that the investor is able to close or the cost and time it is spending to negotiate.
Second, the laws have changed – in some cases dramatically. We had a pretty significant overhaul to our tax code last year and we are now dealing with issues like new privacy and data security concerns both in the U.S. and globally with the introduction of laws such as the European Union’s GDPR. In negotiating these deals we need to consider digital assets, blockchain and internet coin and tokenized offerings which may implicate SEC, CFTC and other regulatory agencies and approvals. We also have Dodd-Frank and crowdfunding. We may need to deal with FCPA, TCPA or other regulatory requirements specific to the business. There are new employment-related issues to consider, not the least of which is the #MeToo movement. This is just a small list of the items that jump to mind when considering the legal landscape in 2007 vs. 2019.
Finally, as one of my colleagues wrote in an earlier blog post – even boilerplate should not be considered boilerplate. There are items, like notice provisions, that have changed because of new means of electronic communications (is a text message adequate notice and what consent is required for this to constitute adequate notice under corporate statutes?). Are items such as limitations on liability, limitations on and exclusivity of remedies and no third-party beneficiaries appropriate in the particular deal? For example, I have been negotiating a joint venture where there are certain agreements being negotiated by one of the parties directly with a third party – should the other partner in the joint venture have the ability to enforce those agreements even though it is not a direct party?
The bottom line for me is that knowledge management, templates and precedents are good – but only to a point. It requires that companies and their counsel are diligent about thinking through the issues, understanding the business objectives and keeping up with developments – both legal and business. Never accept at face value that the document you used for one deal will work for the next, even if on the surface they may appear to be on the same or substantially the same economic terms. Doing the same thing over and over again is easy, change is hard, but not constantly changing and evolving can have adverse consequences for you and your business.