VC Rookie Mistake #2: The Postnuptial Agreement

My husband and I hosted an engagement party over the weekend where the chatter turned to the new phenomenon of the “Postnuptial” agreement. The banter that ensued led me to thinking about VC and the tangled web we weave of agreements…

(Amazing! An analogy that does not draw from poker! How entirely out of character for me!) 
First of all, I should say that this problem plagues rookies and veterans alike. Secondly, let me say that I am not an attorney (I don’t even play one on TV), so kindly take this advice with that caveat in mind. Okay, disclaimers aside, I do feel strongly about this subject of READING WHAT YOU SIGN. I mean, jeez! What does it take to get a freaking partner to read the legalese associated with HIS/HER PERSONAL STAKE IN A PARTNERSHIP?

Apparently, quite a bit of effort. So, here is some food for thought for you intrepid souls.

The Postnuptial Agreement
So, what exactly is a postnuptial agreement? Well, it’s a pre-divorce agreement, of course! I’ve never seen a Partnership Agreement scrutinized so carefully as when a potential separation is in the air. But what is truly annoying is the myriad of e-mails I’ve received in the intervening years between hire and “the postnup”, all indicative of a cursory if any understanding of a *very* important and binding document that all partners have signed.

From Postnuptee (you)
Year 2: “What is my vesting schedule?”
Year 5: “What is my ownership in Fund X?”
Year 7: “Um, just curious, what happens if I get disabled? Divorced? Blow this taco stand?” 
From Postnuptors (your partners)
Year 7: “How much does that idiot Joe Blow own?”
Year 7: “How best can I screw him out of his carry?”
Year 7: “Can I enforce a gag order?” 
From CFO (me)
Any Year: “Refer to Section X.X of the Partnership Agreement which states, ‘…’”
Any Evening after 10pm: “You signed over your ownership to me long ago, with the agreement that you would fund the contributions. Don’t you remember signing that document? Here’s a copy in PDF attached.”

I call it a postnup because most of the time terms of separation are hammered out after the fact. Because the original document just won’t do. I guess we are all starry-eyed and optimistic when we land a new gig. Indeed, the mere *privilege* of working in VC is often enough to have newbies quickly (and gratefully) scratch out their John Hancocks on single-page signature pages (WITH NO ORIGINAL AGREEMENT ATTACHED).

And, as I said, this plagues veterans as well. Indeed, I would say even more so.
So. You require that your entrepreneurs can deliver an elevator pitch and explain their product to a twelve year old. Similarly, you should be able to readily answer some very basic questions about the details of any legal document you sign in your illustrious VC career. The following are just a few that come to mind:

“What is my ownership amount?” (percentage, points, dollar amount – be able to express them all 3 ways)
“What are my voting rights?”
“Is liability joint and several? And what the heck does that mean, anyway?”
“What is my vesting schedule?”
“Is my carry payable in cash, note, cashless reduction of management fee or a combination?” (know how much of each)
“How many votes to kick my butt out of here?”
“Is there a clawback provision?” (i.e., do we pay back committed/contributed before I eat on my carry?)
“What is my current liability with respect to clawback?” (if you don’t pay back committed/contributed first – a good number to keep track of…)
 “How much have I paid in and how much do I have left to pay? What is my loan balance?”
“What are the punitive aspects to leaving the firm?” (these can be fairly onerous…)
“Why am I on the hook for 100% of my capital contributions, even when my carry is whacked to a shadow of its former self?”

You get the picture. 
The Employment Agreement – the true PREnuptial Agreement
In addition to signing a Partnership Agreement, some of you also signed Employment Agreements. Bravo! If you haven’t, you are both in luck and not so lucky. I suppose it all depends on your litigious frame of mind. I always advise to get Employment Agreements in as soon as practical if a firm hasn’t already adopted such a practice. I bet your attorneys have given you the same advice. As a CFO, I have to protect the firm. Sorry, but your individual risk is not my primary concern. HOWEVER, it pains me when you get yourself in a bind unnecessarily. Particularly if you have families.

Without an agreement in place, however, you could argue that the Partnership Agreement prevails. Shoot, most of those are at least 10 year terms. An argument could be made that you are entitled to the equivalent of your ownership percentage X term of partnership agreement X management fee…

That could be some settlement, let me tell you.
Back in the day, we didn’t care much what the terms were. Most VCs were fairly confident that only an utter fool would try to sue and risk ruining their reputation capital (and most VCs were fairly arrogant to think that they would always prevail). Well, times they are a changing. Some people exiting VC realize that their lottery ticket may be their exit plan, not their next gig (um, a lot of firms may have also realized that monetizing the management fee is their model, not making returns for their LPs, but a rant for another day). It would be interesting to know the details of settlements reached in the past five years vs. those in the preceding 15. But, nonetheless, Employment Agreements can help everyone decide what a humane exit strategy is for all concerned – loooong before such an event comes to pass.

Mending Wall
So, without an agreement, you may be at the mercy of a benevolent (or otherwise) negotiation. And you may owe a boatload of money on your carry contributions. And you will likely lose access to cashless contributions, which is typically at the GP’s discretion. You might suffer a clawback prematurely. You might not have a right to your own deal attribution (yikes!). You might not be able to raise a competitive fund right away. You might be subject to slander while you are gagged.

Not good. Which leads me to Robert Frost’s poem, “Mending Wall” and the famous proverb, “Good fences make good neighbors.” Equally, good legal agreements make good partners.

Do you know what yours says?
I do. 
Okay, back to the audit/tax season grind. Here’s a shout out to my buddy, Kai Tse, who indoctrinated me at Garden City on Saturday morning at the 6/12 table and let me get out of there in the money (barely) and with plenty of time to order sushi and prepare for Amy Castronovo and Brian Berliner’s engagement party. Sweet.