I’ll start out by saying that we never charge a portfolio company for our legal fees. Whether or not we are the lead investor, we look at legal fees as just a part of doing business.
That said, let me tell you why it is 100% reasonable for portfolio companies to reimburse their lead investor’s legal fees.
In most rounds (with the exception of party rounds) there is a lead investor who assumes 90% of the diligence and legal burdens. Each of the investors in the round benefits from the work done by the lead investor but the non-leads don’t pay any of the expenses. The lead could theoretically pass the hat around but that would involve many frustrating 1:1 deals and would almost certainly not result in a fair split of the legal/diligence fees. When the lead investor “charges” the company for the legal fees they are essentially taking a short cut and making all investors pay a fair share through the company.
Now the obvious response to this is if the round is only buying 20% of the company then charging the company for legal fees means that prior investors and the company’s employees unfairly bear the burden of the remaining 80% of the legal fees. On its face this is a compelling argument but remember the legal fee reimbursement isn’t sprung on the company at the last minute, it is a default provision included in the initial term sheet.
If the company believes it shouldn’t bear the actual economic impact of the investor’s legal fees the solution isn’t to push back on the legal fees, its to slightly raise the valuation.
BOOM! Everyone is happy. Each investor bears proportional responsibility for the cost of getting the deal done and the company gets the deal it thought it was getting from the start.
To all the founders out there, in case you missed it, I just gave you one more arrow in your quiver when it comes to negotiating your valuations. Now sally forth and brow beat some hapless VC.