As a venture-backed company on a quest to modernize access to public finance, Neighborly occupies two radically different worlds. In one, we work with venture capitalists to raise money so that we can grow and achieve our strategic objectives. In the other, we are constantly collaborating with public finance professionals and looking for ways that we can empower municipalities and investors alike. In both cases, the efficient allocation of capital from the investor to the enterprise ultimately drives value creation. Capital enables the startup to acquire crucial resources and talent to build out its vision of the future. On the municipal side, capital enables cities and communities to finance projects that serve as the infrastructure to everyday life – roads and bridges, schools and parks, electricity grids and water utilities.
At Neighborly, we know that to be successful in our own mission, we must think deeply about both worlds. Having worked with both venture and municipal finance, we have come to believe that there are ways in which innovations in one can be applied to the other in order to facilitate the more efficient allocation of capital. In particular, we have seen how Silicon Valley has been especially effective at streamlining the various legal processes of forming an early stage startup. This development was able to occur because founders, investors, and attorneys agreed to and standardized a canonical set of terms and conditions that did away with the need for lengthy legal dialogues. In our mission to do the same for municipal finance, we have been able to find much inspiration in the development of these documents.
By the late 2000s, the capital needed to start a company and create a product had declined precipitously thanks to the advent of cloud computing, open source software, and various developer platforms. Despite these developments, many in Silicon Valley noted that the size of the financing documents remained just as bloated as before. The documents included many important provisions and clauses to protect and mitigate risk to investors, but also accounted for scenarios that would not become important until much later in a startup’s development (such as acquisitions or public offerings). This, as Ted Wang of Fenwick & West noted¹, may have been pragmatic when venture investments were $3M to $5M, but became cumbersome as startups became leaner.
As a result, in 2009, Orrick, Herrington & Sutcliffe (“Orrick”), a global law firm, released a suite of model legal documents² for articles of incorporation, founder’s documents, and term sheets. As an early pioneer of open-source venture documents, Orrick was particularly far-sighted not only for codifying the early standards for startups’ legal documents, but also for automating term sheet creation. Founders simply had to fill out a set of online forms to obtain industry-standard legal documents from Orrick. Since then, there have been many other efforts to add to the corpus of open-sourced legal documents. In 2010, Ted Wang of Fenwick & West, a technology law firm, released the Series Seed documents³, a standard set of documents for seed stage financing which sought to reduce the unnecessary time and costs for financing transactions. Not long after, in 2011, with help from Orrick, the National Venture Capital Association introduced its own set of model legal documents with the express purpose of standardizing and expediting financing discussions. Citing the considerable time and money (some $200M annually) that investors, founders, and attorneys spend every year in annual fees and consultations to close private financing rounds, the NVCA sought to provide a set of documents that would greatly expedite such discussions. In 2014, 500 Startups followed suit, announcing its “KISS” (Keep It Simple Security) documents⁴, which proposed a set of standard documents for convertible debt and equity financing agreements. Their express purpose was, again, to save founders and investors time and money with common and understandable terms that are widely agreed to be fair and efficacious.
Most recently in February 2016, Y Combinator, in collaboration with John Bautista of Orrick, released a set of standard documents called SAFE (Simple Agreement for Future Equity)⁵. Previously, most early stage financing was accomplished through convertible debt, a popular instrument that helped bridge a startup’s capital needs while deferring questions about valuation until the next round of financing. The note would then convert to equity, sometimes at a discounted rate or lower valuation to compensate the investor for taking risk earlier. SAFEs built upon the previous corpus of open documents, addressing some of the problems with convertible notes – primarily, the risk of insolvency to the startup and the myriad rules the investor had to follow as a lender – while preserving their flexibility. The documents included standard templates for convertible debt analogues: capped or uncapped notes, with or without discounts. Now, hundreds of investors have invested hundreds of millions of dollars in startups through SAFEs.⁶
Nowadays, there are even startups like Clerky, a platform started by two Orrick associates that provides automated legal services to startups. According to Orrick, by December 2015, over $500M had been invested through the Clerky platform.
As a venture-backed company, we have seen how venture capital has honed and streamlined the early stage company financing process, which was once a lengthy back-and-forth interaction between entrepreneurs, venture capitalists, and legal counsel. By agreeing on a standard set of documents with a concise, well-understood, and flexible set of canonical terms and agreements, the venture ecosystem has been able to collapse the cost structure for early stage financing, drive down unnecessary transaction costs, and expedite capital deployment.
This achievement was able to save time and money for all parties involved – entrepreneurs, financiers, and attorneys alike. Attorneys no longer had to “re-invent the flat tire on a daily basis” (as the NVCA puts it) and spend precious human resources and countless unproductive hours doing so, entrepreneurs were able to focus on building their business instead of ironing out legal minutiae, and venture investors were able to close deals much more quickly.
Because the founders, financiers, and lawyers agreed to conventions, startups started to use these standard, open-source documents in lieu of the traditional drawn-out and repetitive editing process. Since these documents were designed to be fair and transparent, they were able to achieve consensus early on as the de facto starting point for further discussions. And since they were designed to be simple, the documents were flexible enough to be changed for any given situation and templated for future use.
Part of our quest involves doing for public finance what the series seed documents did for early stage venture finance, so that cities and communities can enjoy the same streamlined access to capital that startups do. The borrowing process for municipalities remains bloated, drawn-out, and opaque, just as venture documents were prior to their standardization. Since the cost of debt issuance is too high, municipalities often delay important projects or even forgo them entirely. The result is that cities are unable to deploy capital to some of the most underserved causes: schools lose art programs, communities do without community centers, and utilities and energy infrastructure remain dilapidated.
We are proud to be working with Orrick, an experienced leader in both municipal and technology law in bringing the same legal and technological innovations to municipal finance. Just as entrepreneurs can consult the various online documents to properly and quickly incorporate and raise early stage financing, we hope that one day, through the Neighborly platform, municipalities will be able to quickly issue bonds to raise money to invest in their communities. Our communities deserve as much.
Thanks to Andrew Han for contributing.
Special thanks to Mitch Zuklie (CEO), Justin Cooper (Co-Chair of Public Finance), and Jolie Goldstein (Chief Communications Officer) from Orrick for their contributions to the article and continued partnership and guidance.