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It is, and you can mostly thank your tax law. (As a side note, tax law is the reason for a lot of not-so-obvious things companies do, like options.)
A small preamble — I’m going to gloss over some of the specific tax terminologies here, mainly because I’m not a tax accountant and if I tried to provide the precise details, I would likely get them wrong.
As a founder, you shouldn’t want any large portion of your investment dollars to go to anything but building your business.
So why do companies have to foot the legal bill of the investors? After all, they are the ones with all the money! Simply put, by having the legal bill paid by the company, the fund is embedding the legal cost of the transaction into their cost basis for the investment. By doing this, on an exit, they get their investment plus legal fees back before they have to start paying taxes. As we all should know, you only pay taxes on the difference between the purchase and sale price on an investment.
If a fund were to pay its legal bills outside the investment, the tax treatment is as an expense. Since a fund doesn’t have any revenue, those costs would essentially be ‘wasted’ from a tax purpose. No one, investor or otherwise, wants to waste a potential tax offset.
On one investment, frankly, the fees lost to reduce tax basis wouldn’t make a big difference. A fund doesn’t just make one investment. It makes potentially dozens. So over an entire fund, all those legal fees add up, and the aggregate amount becomes non-trivial amount. For legal fees, the solution is easy: bake the fees into the investment by having the company agree to pay them.
That said, as a founder, you shouldn’t want any large portion of your investment dollars to go to anything but building your business. It’s okay to negotiate the amount the company will pay. Investors and their counsel will, in turn, likely negotiate a fixed fee.
That said, if during the closing process your lawyers create a lot of extra and/or unnecessary work for the investor’s legal team, expect to get some pushback.
If I can give a final piece of advice on legal fees, the best way to keep closing costs reasonable is to hire a legal team who have completed a large number of technology company private transactions. You don’t want to be paying to train your lawyers — I’ve seen seed deals with six-figure bills when the total should be low five’s or high four figures. We at Impression Ventures use Osler, and can’t recommend them enough to startups. There are many other high-quality firms out there. A search of the Startup North Facebook group will get you additional recommendations.
Sarah’s take
To Christian’s point to hire a legal team with experience in multiple technology company private transactions, building this relationship not only sets you up for an efficient financing closing, but also creates an opportunity for ongoing legal and strategic counsel.
Great startup lawyers should be able to go beyond the closing documents, and leverage their network and insights to provide tangible value. Experienced counsel can introduce you to other emerging entrepreneurs as you work to level-up your CEO skills, VC firms as you raise subsequent capital, and potential board members as you focus on improving governance and learning from more experienced operators. Value creation through technology startups has grown, and as a result, so has startup-focused practice groups and program packages.
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