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The “Hold Your Nose” theory of legal documentation

Investors sometimes join into investment rounds that have been pre-negotiated by others, receiving the paperwork already created by attorneys from that negotiation.  It is not uncommon for a sharp investor to discover a “stinky” clause or two in such agreements when reading them in preparation for signing.  Bill Payne came across just such a stinky clause in a recent deal we both were late in the process of joining.

Changing the deal that late in the game is nearly impossible, after other investors have already completed their documents and the deal supposedly put to bed.  So what does the latest tag-along investor do?

You can tell from the title of this insight that the usual result is to passively sign while holding the nose, a trick perfected by experienced investors suffering this malady for not the first time.

What if it is the company attorney or entrepreneur that finds the stinky clause so very late in the game?  How do you confront the investors who have already agreed to terms and even perhaps signed their documents?  Is it worth risking the deal to negotiate a late change during the equivalent of the ninth inning?

[Email readers, continue here…] The answer is obviously in the importance of the issue to the person discovering it.  In most cases, the probability of DB Concordia2whatever the clause being triggered sometime in the future is slight, and therefore the risk remote.  So it is a bet against the event made with chance on your side.

Then again, it is those improbable future events that end up causing lawsuits years later, often just because a party to an agreement did not understand the implication of a clause or even a document.  We hire attorneys precisely to help us prevent future conflict by resolving issues before they happen.

Most of us will let the matter slip and sign while holding our nose, a feat in itself (holding the nose, paper and pen at the same time).  Some of us will pass on the deal rather than confront the issue, especially if it is an important one to the late signer.  And that often happens when just such an issue has bitten the candidate investor in some past deal, making the likelihood of such negative reaction higher with sophisticated, long time investors.

Maybe there are skunks in the woods that don’t even know they smell.  Or maybe there are targets in the woods without the capacity to even catch the odor of a bad negotiation or deal documentation.  Either way, there are risks in deals we sometimes never catch – that later catch up to us in the most surprising places and times.

  • Michael O'Daniel

    To be more precise, Dirty Harry actually may have said, “Is that a risk you’re willing to take?” It scans better anyway.

  • It is worth bringing up the “stinky clauses.” I’ve had success approaching the entrepreneur with “this is unusual and frankly does not make sense.” The push was for a win-win. The entrepreneur cared about treating his investors well–this was critical.

    In one deal, we were “last in” and had a smaller investment in the round. The legal docs were missing important clauses (e.g., no information rights).

    To “save money” the lead investor suggested that the company counsel write the term sheet and legal documents. Small wonder that certain investor protections were missing.

    Although we didn’t get everything, the “deal killer” problems were resolved. For the others, we made a judgment call (and held our noses). As a result of our efforts, all investors in the round got better terms.

    We liked the entrepreneur, and he demonstrated a high level of integrity. If the entrepreneur had been intractable, we would have walked.

  • Frank Castle

    Point well taken, Michael, but Dirty Harry actually asked, after saying that he didn’t know if he’d fired five or six shots, “Do you feel lucky………well, do ‘ya punk?”

  • Chris

    You will invariably find a bad clause in any deal you do. Just look at the Fiscal Cliff package… However, I have encountered this many times in doing early stage investments, and the decision for me is simple — if the term is of such importance to be a go/no go item, I simple and honestly convey that fact to the Founder and let them make the call. If it is a reasonable request (and the Founder is reasonable), they will often come around, if not, there are another 50 deals in front of you at any given moment, so move on and feel good that you held your ground and did not contribute to the frothiness of an unreasonable marketplace. [Last time this happened to me, it was AFTER the company had taken money on the round and already signed docs. with other investors. But my request was reasonable – as was the Founder – so the change was ultimately made to all document – both backwards and forwards, to the benefit of all.]

  • Michael O'Daniel

    When one encounters stinky language and is contemplating whether or not to ask for changes, it’s good to remember that “What’s the worst that could happen?” eventually will. As Dirty Harry said, “Is that a risk you want to take?”

  • In my experience if you are ‘negotiating’ with people whose lawyers are inserting ‘stinky’ clauses to trip up/setup litigation at a later date you are not getting the reflection of integity I require for all my deals. Walk away if there is not full flexibility and willingness to amend problem clauses. There is always another deal. I always trust my gut. No uh-huh. No deal.

    Happy New Year,



    Well penned my friend.

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