A major financing can take on a very vibrant life of its own. Between lawyers on both sides, partnership dynamics and/or board approvals, bankers and accountants, the CEO is at risk of losing control of the deal at just about every turn. Accounting, financial, and legal diligence are just the beginning. I joke that I nearly got a J.D. in the process of papering our Series B with Rakuten. In this post I’m sharing my lessons learned with other CEO’s.
I rarely run a draft of a blog post in front of anyone, but I did ask my attorney Larry Gennari of Gennari Aronson to vet this one. I wasn’t worried about possible legal issues, I just wanted his point of view. As such, some of these thoughts were enhanced by Larry’s input, having transacted dozens of successful financings in the course of his career.
1. Own the negotiation. When it comes to establishing any key business terms or partnership agreements, the CEO really has to be doing the talking. In the case of our deal with Rakuten, we sketched out the basic terms in about 15 minutes, sitting in an auditorium, after an event. (To an outside observer it probably looked like a very casual chat—it most certainly was not!) To both parties’ credit the basic agreement held throughout the extensive weeks following. But whenever any key deal terms had to be sorted out, I always returned directly to my two main Rakuten counterparts. Why is this meaningful? Because it would be very tempting, as the weeks roll by and fatigue sets in, and you are dealing with a boatload of exotic legal and accounting concepts, to defer to the attorneys to get things hammered out. This would be a very expensive mistake. The two principals on a deal—the decision makers—are going to be the fastest (and cheapest) route to resolution. Don’t cede that key responsibility to your attorney. Ever. Your attorney can help you sort out which are “those” issues (though you will most likely have no doubt) and if they don’t, get a new attorney.
Larry adds that the bottom line is that the principals should agree on the principles—and then get a sanity check from advisors before reducing the discussions to a term sheet. In his experience, at times, the simplest of business agreements can have adverse consequences that defy common and business sense (thanks to the tax code).
2. Don’t sign anything you do not understand. Although there are some boilerplate parts of a financing where you can defer to your attorney (indemnifications, for instance), don’t do that very often. One very basic rule of thumb: if any clause contains a number, make sure you understand it upside down and backwards. But it goes further than that in terms of mastering all investor preferences and the classification of different shareholders. Rather than guess, I learned to flag my confusions very explicitly. My most memorable moments included a late night call where I practically shouted, “Guys! Guys! You are liberally throwing around technical jargon that I have only ever heard on TV. And I’m the CEO about to permanently commit a team to this deal. Do you know how scary that is to me? I can’t proceed until I understand.” (Fortunately a good attorney or advisor should be very skilled at listening and responding to your questions, in plain English, as mine were.)
Similarly, I chose not to defer to the steamroller of negotiations and broke a somewhat tense two-sided legal conference call wrangle by saying to the Rakuten attorney, “I know we have never met, but I am a natural blond. What does that mean? It means that every word in this deal has to pass the ‘natural blond test.’ If I don’t understand it, it won’t get signed.” (Using humor to break a logjam was probably more important than anything else, honestly. I think the attorneys had nearly forgotten that I was part of the call after over two hours of back and forth.) Even if you aren’t able to pull the “natural blond clause”, you must make sure you are slogging through everything you are signing with full understanding. Lean heavily on your attorney and/or banker until you have it all clear in your head.
3. Sometimes only you can simplify. After you set the deal terms your attorneys have to play the critical role of documenting the agreement and anticipating eventualities that you would never in a million years imagine. This is something I learned to really appreciate. For the most part I stood aside as they did their jobs in this area. But I distinctly remember one time when, because I had the benefit of a little distance, I listened to some complicated and convoluted valuation formula being conceptualized and said, “Guys I just want XX. They just want XX too. Can’t we just say XX?” It was a potential breakthrough. It made me feel like I was doing my job while the attorneys were doing theirs.
4. Protect your team. For the most part you (and if you have one, your CFO) are isolated in the deal process. No one on your team could possibly understand the complexity and inhuman demands of the transaction. Too bad. Suck it up. But your loyal team members will most certainly understand, someday, if you sell them down the river. So protect them. Protect your existing investors. They joined you and funded you because they trusted you. Do not betray their trust. I had moments during our transaction where I was battling very hard for them and risking a lot of social capital with my counterparts at Rakuten. But I always knew the deal was not worth anything to me if success could not be truly shared.
5. Be prepared. Before you go into a financing, look at everything: contracts, cap table as it impacts team, outside litigation—and have a response/plan ready as best you can. Some issues—like founder ownership and tax issues—require a longer look, while others –outside litigation—require an explanation up front so the other side won’t think you are hiding something. Maintaining credibility and building trust from the outset is key and can bridge gaps and bumps that inevitably occur in any deal
I hope this helps a couple other CEO’s. I’m not sure these words would have meant much to me a couple years ago, but I’m banking on the superior retention and foresight of my readers on “getting” this. I’ll probably have to reread this myself the next time I’m doing a deal. I am, after all, a natural blond.