[harryh]

Serious question - how is this still the case, or make any sense? Wouldn't it be in the investor's interest that the company doesn't spend $60K out of their raise on this, and instead on hires, product, etc?

No, it would not be in the investors best interest to make that change. Under the current system all of the money spent is used to buy shares in the company. Under a system where the VC firm was responsible for their own legal fees then $25k (or whatever) would go directly to the lawyers instead of buying shares so they would end up with a bit less ownership.

EDIT: To be clear I'm not saying that I am in favor of the status quo. I am not. I'm just saying that it is understandable given the incentives of VC firms.

[arohner]

The VCs aren't the investors here.

There are 3 parties, the startup, the VCs and the LPs. The LPs are generally pension funds, college endowments, and sovereign wealth funds, i.e. institutions who can write $10M-$100M checks. The VCs are their agent, like a real estate agent helping you buying a house.

While VCs put their own money into the fund, generally the vast majority of the fund money comes from the LPs. The VCs get paid 2 and 20, 2% of the fund per year for things like salary and rent, and the first 20% of profits from the fund when it ends, in 10 years. Because of this structure, they don't get to treat the fund money as their own personal piggybank.

No matter who pays, the cost of a deal is going to be <money startup receives> + <startup legal costs> + <VC legal costs>.

Raising the cost for the VCs, without changing 2 and 20 just results in increased costs for the VC. Paying their own legal costs means they'll do fewer deals, with larger check sizes.

[logicallee]

you missed the parent's point.

if it paid its own legal fees it would get that much less equity.

imagine I said "I'll invest 1M at a 2M valuation but you have to burn 800K of it in a bonfire." vs if I said "I'll invest 200K at 2M valuation but I'll celebrate by burning 800K in a bonfire."

The same thing happens to the money (it burns in a bonfire / goes to the lawyers) but in the first one I have 50% of your company and in the second one I have 10% of it.

Because in the first one I added it to the equity investment before making you pay it.

[technotony]

Also, then the $25k would come out of the management fee rather than the LP's capital. Even less incentive for the fund manager to go this route!

[harryh]

Yup, that too.

[acjohnson55]

...of a financially healthier company!

But I suppose it's really kind of a matter of accounting. As long as the outlay of the investors is equal in both scenarios, the post-money situation should be approximately the same.

That said, in reality, the VCs probably have a better understanding of the real costs of the fundraise, so I can see the argument that they'd be best served in the long-run by minimizing surprises for their portfolio companies.

[anotherfounder]

It really seems short-sighted, since the focus should be on making sure companies have enough runway, comfortable and focused on product. For an early stage startup, $25K- $60K can be an extra part-time/full-time (depending on location/function) employee.

[harryh]

That goal is not in conflict with what I said.

Say that a company needs $X to have "enough runway." The VC firm can either invest $X and pay for the firms legal fees themselves or invest $X+legal_cost and have the company pay the fees. In the latter scenario the VC firm will probably end up with a greater ownership percentage.

It is worth noting, however, that it might not really make any difference. Much like tax incidence who directly pays for the lawyer really might not matter much in terms of where things end up in the end. The cost will always, to some degree, be shared by the firm and the company.

[anotherfounder]

I see. So, the choice is essentially : A: <Capital> from which the startup can pay legal fees OR B: <Capital> + <Legal Fees> where the Capital is probably less as VC firm is probably accounting for Legal fees separately.

Even then, it is interesting that the optics of this doesn't bother investors.