[Mikho]

Thanks. Good read. I'd say legal fees don't influence the cap table and, hence, founders' share unless founders pay them with equity. So, it's a matter of the way the investments are spent, not the cap table structure. But definitely spending relatively big chunk of money on legal at an early stage leaves less money to use for the primary purpose and later dilutes founders' share with inevitable new financing.

[robocat]

I really like your point. Okay, this is fun, I’ll try another hypothetical.

Start with the fact the company will be worth a billion (all the gains are outliers and you have to play to win), and then inductively work out costs backwards.

Objective function: Let’s assume every productive hour in the first year linearly increases your returns, so spending 5 weeks chasing investors reduces returns by $100 million. Every angel dollar returns 30x, so the marginal cost of $30k legal fees is actually $9 million (ignoring other non-trivial factors!)

Constraints: you must have certain things (money, employees, legal documents, advice) so the outcomes are extremely sensitive to the constraints. We talk about a constraint like legal fees, but removing that constraint should theoretically have a massive impact on viability, IPO price, and founder returns. It isn’t linearly a few percent ($x kilodollars of a $x megadollar investment).

Startup economics for founders are highly unintuitive and non-linear, with exponentials over time causing thought failures. You have made me realise I don’t have a good feel for this AT ALL.

Addendum: one of the sentences on siliconhillslawyer.com talks about smart VCs counter-intuitively forcing money to be wasted in early rounds. It gives the VCs more leverage with founder negotiations about equity ownership when the money runs out and another round is needed.

[Mikho]

In general, any decision in the early days has a long tail and consequences. Hire the wrong person—and start-up wastes not only a semi-annual or an annual salary (more than $30K) but also a lot of valuable time. Sometimes wrong hire could kill a start-up just by wasting all the money early.

It's good to optimize in the early days but it's also important to not be penny wise and pound-foolish. In general, today there are a lot of standard deals, documents, and lawyers who specialize in start-up deals. Properly speaking, for a law firm it is usually worth making its services inexpensive and accessible for fresh start-ups since it's the firm's investment in keeping these start-ups as clients should they grow and become big. It's not worth it for a lawyer to rip off a start-up for pennies and lose this start-up as a client when it becomes big. Not to mention losing reputation among other startups. So, for a start-up, it's worth finding the right lawyer who works mostly with start-ups and not rely on "general practices" pushed by a VC or VC's own loyal lawyer that surprisingly serves only this VC's pocket.

Taking money at the early stage is a tough game. When founders take an investor's money, the investor's business model becomes the business model of their start-up: only outlier growth and outsized returns. The longer start-ups bootstrap the better it is for founders and for business. Preferably, to bootstrap till the product-market/fit and take money only as a fuel for growth. This way a start-up has a lot of leverage in fundraising since it doesn't need money to survive—just to have more fuel to make the fire bigger.

Calculations in my post make it obvious that any pre-seed round (including Y Combinator's deal) results in founders losing a very big chunk (30%+) of their start-up by the time they close the next Seed round or priced round in YC'S deal case.

Nevertheless, if there are no other options and the only one is to take money early, then so be it. It's better like this than nothing at all.