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Avoid Startup Failure

Learn the top ten causes of failure for technology startups and how to turn them to your advantage.

What People Say About Our Book

Excellent book by Phil! I have known Phil for over a decade and when I was in private practice, I referred clients to him. He has deep knowledge and understanding of the issues and this book offers practical advice provided in a narrative format. Since he was with a large Fortune 500 company acquiring companies and is now in private practice, Phil has a unique perspective.
SPS
AVOID STARTUP FAILURE! is an excellent guidebook for those who are starting a business. Philip Crowley gives excellent advice in a way that is easy to understand and implement for new entrepreneurs. He emphasizes the importance of protecting your ideas early in the process and when to engage legal assistance to make sure your are taken care of through the that process. Recommend this book highly!
Andrea L. Colby
AVOID STARTUP FAILURE is written by someone who has seen it all and worked with tons of startups to make sure they don't screw up their startup from the start. Phil was my attorney when I started my first company which I later sold to a publicly traded company and he was pivotal to its success and making sure we didnt make the mistakes early on that can ruin your business...
Kassandra Kist
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How the book is organized

Vision

This book will help new technology entrepreneurs avoid some of the easily identifiable errors that markedly decrease their chances for success and the financial rewards they may receive.

Steer

Change first sentence instead of “in the process of growing technology companies” use “in the process of growing a technology company”.

Accelerate

In first sentence change “starts” to “startups”. In second sentence add after “those with whom he dealt” the following: “and suggest some approaches he could have taken to avoid the problems he caused for himself.” In the last sentence, change “with documents” to “with the legal documents”

What’s in the Book?

  • Storytelling over Lists: This book uses a fictional story (an allegory) about an inventor, Sam Champion, to illustrate best practices and common pitfalls in bringing inventions to market, arguing that stories are more effective learning tools than simple lists of rules.
  • Patents Don’t Guarantee Success: A patent grants the right to exclude others from using your invention, not necessarily the right to use it yourself. You might need licenses from other patent holders to commercialize your product, and patents are country-specific, requiring separate filings for international protection.
  • Real-World Application: After the story, the book analyzes the top ten reasons why tech startups fail, connecting these failures to Sam’s experiences to reinforce the lessons learned.
  • Focus and Disclaimer: The book primarily addresses legal and strategic issues related to patents and commercialization, not general business advice. It emphasizes that it’s for educational purposes only and not legal counsel, urging readers to consult with a qualified attorney for their specific situations.
PART ONE
  • Sam’s Upbringing: Sam grew up in a middle-class family where his father, Ken, despite dropping out of high school, instilled a strong value for education due to his own missed opportunities. His mother, Nan, was a nurse, and his father a bus driver.
  • Ken’s Sacrifice: Ken dropped out of high school to support his mother after his father’s unexpected death, a decision he later regretted but which fueled his commitment to his son’s education.
  • Support and Mentorship: Although Sam’s family had limited financial resources, they provided immense love and support for his academic pursuits. A key mentor, Mr. Vincent-Ferer, nurtured Sam’s talent in math and science, helping him overcome the limitations of his school’s resources.
  • Sam’s Drive: Sam excelled in high school, driven by a desire to improve lives through technology and provide a better future for his own family. His hard work earned him a full scholarship to the prestigious State Institute of Technology.
  • Sam’s Entrepreneurial Drive: Sam pursued a technical education to become a technology entrepreneur, eager to use his knowledge to improve lives.
  • Superconductivity Breakthrough: Sam connected with Dr. Barbara Benchley, a researcher developing a more practical superconducting material with potential applications in medical imaging (MRIs).
  • The Publish-or-Perish Dilemma: Dr. Benchley, focused on securing tenure, prioritized publishing her research over immediate commercialization, creating a conflict with Sam’s entrepreneurial goals. Academic institutions often prioritize publishing in journals over-commercialization.
  • Patent Implications: Sam realized that premature publication could jeopardize patent protection outside the US, potentially destroying the commercial value of the invention. He worked with Dr. Benchley and the Institute to secure provisional patents before further publication, salvaging future opportunities.
  • Securing Intellectual Property & Initial Planning: Sam successfully established an agreement with Barbara to ensure the Institute’s tech transfer office would file provisional patents before public disclosure of her future work. He also gathered his trusted graduate school friends to plan for the commercialization of this work.
  • The Perils of Verbal Agreements & Personal Liability: Sam made the mistake of leasing lab space based on verbal commitments from his friends, who then reneged on their financial pledges. This left him personally liable for the full year’s rent, highlighting the importance of formal contracts and the risks of assuming financial support.
  • Damage Control & Negotiation: Faced with a significant financial burden, Sam leveraged his network at the Institute to negotiate a reduced payment, demonstrating the importance of resourcefulness and perseverance in overcoming unexpected obstacles.
  • Formalizing the Venture & Underestimating Legal Requirements: Sam incorporated “Technology Ventures Inc.” through an online service, aiming to streamline the licensing process. However, he neglected to seek legal counsel, potentially overlooking crucial legal requirements and setting the stage for future complications.
  • Negotiating Licensing Terms: Sam’s company, TVI, faced complex licensing requirements from the Institute, including milestones like raising significant capital and granting equity in exchange for an exclusive license to Barbara’s inventions.
  • The Option Agreement: The Institute offered TVI an option agreement, which gave them the right to an exclusive license if they met specific conditions, rather than an immediate, guaranteed license.
  • Dismissing Legal Counsel: Despite the complexity of the agreement, Sam, with the support of his friends, decided to forgo legal counsel, believing the Institute’s documents to be standard and wanting to save money.
  • The Decision to Proceed: Confident that the option agreement signaled the start of TVI’s official journey, Sam signed the document, demonstrating a willingness to move forward despite potential risks.
  • Equal Equity Distribution & Initial Enthusiasm: The founding team, including Sam, Alex, Bonnie, and Diego, opted for an equal distribution of company stock, despite varying time commitments, fostering a sense of shared ownership and motivation.
  • Rapid Progress & Ambitious Goals: The team made significant technical progress in developing Barbara’s superconducting materials, fueled by the dream of creating a revolutionary product and achieving substantial financial success.
  • Attrition & Shifting Dynamics: Unexpected life events, such as a prestigious job offer and family emergencies, led to the departure of Alex and Bonnie, significantly impacting the team’s workload and dynamics.
  • Sam’s Perseverance & the Final Challenge: Despite losing all his original partners, Sam continued to push forward. After a breakthrough, he was left as the sole member of TVI, but he needed to find one million dollars to secure the patent license.
  • Seeking Angel Investment: Sam, after exhausting other funding options, approached Sanford Sharp, a seasoned angel investor known for his shrewd negotiation skills, seeking the critical one million dollar investment.
  • The Negotiation & Valuation Gap: Sanford offered the needed investment but proposed taking 50% equity in TVI, valuing the company significantly lower than Sam’s own estimation, highlighting the power dynamics in investor negotiations.
  • Reliance on Investor’s Legal Team: Sam, aiming to save costs and assuming standard documentation, agreed to let Sanford’s lawyers handle all legal paperwork, potentially overlooking crucial details and relinquishing control.
  • Reflecting on Equity Distribution: Sam recognized the imbalance in equity distribution, considering the varying levels of effort from the original founders, but ultimately accepted the current situation as irreversible, showcasing the lasting impact of early decisions.
  • Investor Control & Hidden Costs: Sam discovered unexpected legal fees deducted from the investment, and that Sanford Sharp had the right to appoint a board member, demonstrating the fine print’s impact in investment agreements.
  • The Introduction of Board Oversight: Sanford Sharp’s son, Brad, joined the board, bringing a structured, MBA-driven approach that clashed with Sam’s more informal style, leading to increased scrutiny of Sam’s decisions.
  • The Importance of a Formal Business Plan: Brad forced Sam to develop a detailed business plan, revealing the gaps in Sam’s assumptions and highlighting the necessity of strategic planning beyond just technical development.
  • Loss of Autonomy & Investor Rights: Sam realized the extent to which he had relinquished control through the preferred stock agreement, as Brad asserted his rights to approve key decisions, illustrating the shift in power dynamics after securing investment.
  • The Value of an Exclusive Patent License: Sam recognized the importance of securing an exclusive patent license to protect and commercialize Barbara’s inventions, highlighting the strategic advantage of exclusive rights.
  • The Binding Option Agreement: Sam discovered that the terms of the patent license were already predetermined in the previously signed option agreement, eliminating his ability to negotiate further.
  • Unexpected Costs and Fees: Upon signing the license, TVI faced significant unexpected expenses, including past patent filing and maintenance costs, as well as the Institute’s legal fees.
  • Limited Negotiation Power: Sam’s attempts to defer these payments were unsuccessful, as the Institute maintained that the terms were standard practice, resulting in a substantial and unanticipated cash drain for TVI.
  • Staffing and Equity: Sam navigated the challenges of building a team, including discussions about equity distribution to attract talent, while lamenting the limitations imposed by the preferred stock agreement.
  • The Dangers of Verbal Agreements: Sam’s handshake deal with Software Wonders backfired when he discovered they retained ownership of the software, leading to a costly buyout and highlighting the importance of written contracts for intellectual property.
  • Investor Intervention and Legal Cleanup: Brad Sharp’s reaction to the software ownership issue resulted in mandatory legal intervention, requiring TVI to hire Sharp Enterprises’ lawyers to rectify legal oversights and establish formal employee agreements.
  • Increased Investor Control and Legal Expenses: The board expanded with the addition of Sandra Redmond, further solidifying investor control, while TVI faced escalating legal bills, significantly depleting their initial investment.
  • Shift in Leadership: Brad, leveraging his MBA credentials, proposed a change in leadership, suggesting he take over as CEO, displacing Sam from the position he had held since the company’s inception.
  • Justification and Investor Alignment: Brad and Sandra justified the change by emphasizing the benefits to all stockholders and suggesting that Sam’s technical skills would be better utilized as CTO.
  • Loss of Control and Demoralization: Despite his significant contributions, Sam recognized the power dynamics and reluctantly agreed to the change, feeling demoralized and acknowledging the loss of control.
  • Acceptance and Resignation: Sam, though deeply disappointed, accepted the change, highlighting the challenges faced by founders when investors gain significant influence.
  • Shift in Leadership: Brad, leveraging his MBA credentials, proposed a change in leadership, suggesting he take over as CEO, displacing Sam from the position he had held since the company’s inception.
  • Justification and Investor Alignment: Brad and Sandra justified the change by emphasizing the benefits to all stockholders and suggesting that Sam’s technical skills would be better utilized as CTO.
  • Loss of Control and Demoralization: Despite his significant contributions, Sam recognized the power dynamics and reluctantly agreed to the change, feeling demoralized and acknowledging the loss of control.
  • Acceptance and Resignation: Sam, though deeply disappointed, accepted the change, highlighting the challenges faced by founders when investors gain significant influence.
  • MegaTech’s Success: MegaTech successfully commercialized TVI’s technology for less than anticipated, leading to a highly profitable acquisition by Global MRI Solutions Corp.
  • Disproportionate Returns: While all parties involved received financial gains, the returns were disproportionate, with Sanford Sharp and MegaTech achieving exceptional profits, while Sam’s return was comparatively low given his extensive effort.
  • Sam’s Reflection and Regret: Sam grappled with the feeling of unfairness, questioning whether he could have negotiated better outcomes, highlighting the importance of strategic planning and legal protection.
  • Lessons Learned and Future Considerations: The scene prompts readers to consider Sam’s perspective, encouraging them to reflect on the complexities of entrepreneurship and the importance of understanding legal and financial agreements.
PART TWO
  • Importance of Early Planning and Expert Guidance: The analysis emphasizes the necessity of proactive planning and seeking expert advice to mitigate risks in technology startups, highlighting Sam’s missteps as cautionary examples.
  • Key Mistakes and Their Consequences: Sam’s failures, such as not securing technology rights, incurring personal liability, and relying on inexperienced counsel, are analyzed, demonstrating the potential repercussions of neglecting critical steps.
  • Negotiation and Legal Expertise: The importance of experienced startup lawyers is underscored, emphasizing their ability to negotiate favorable terms and challenge “standard” documents to protect the entrepreneur’s interests.
  • Loss of Control and the Need for Strategic Governance: The analysis points out the disparity in the TVI payout, attributing it to Sam’s loss of control over the company’s direction. It stresses the significance of strategic governance and understanding legal agreements to maximize value and maintain control.
  • Importance of Written Agreements: Technology entrepreneurs must secure written agreements with IP sources to ensure confidentiality and obtain licensing rights, preventing public disclosure and unauthorized use.
  • Risks of Public Disclosure: Publicly sharing research, such as at conferences or in publications, can compromise patentability, especially outside the U.S., limiting commercial potential.
  • Patent Protection Limitations: Patents provide the right to exclude others, not necessarily the right to commercialize, emphasizing the need for expert patent counsel early in the process.
  • Sam Champion’s Example: Sam’s initial oversight in ensuring confidentiality led to potential patent issues, highlighting the real-world consequences of neglecting IP protection, but was saved by the researcher’s continued developments.
  • Personal Liability Risks: Operating a business without a limited liability entity exposes personal assets to business-related debts and liabilities.
  • Benefits of Limited Liability Entities: Corporations and limited liability companies (LLCs) shield personal assets from business liabilities, provided they are operated correctly.
  • Importance of Legal and Tax Advice: Choosing and managing a limited liability entity requires guidance from legal and tax professionals to ensure proper operation and liability protection.
  • Sam Champion’s Example: Sam’s personal liability from leasing lab space without a corporate entity and the continued error of having all founders sign a lease, illustrates the consequences of neglecting limited liability protections, as well as the need for appropriate insurance.
  • “Bucket” Analogy: The company is likened to a “bucket” where all valuable IP should reside, emphasizing the importance of consolidating assets for investor confidence.
  • Investor Trust: Investors prioritize trust, and ensuring all relevant IP is transferred to the company through written agreements is crucial for building that trust.
  • Preventing Future Complications: Failure to transfer IP can lead to delays or prevent future investments, as investors may be wary of incomplete asset consolidation.
  • Sam Champion’s Example: TVI’s experience with incurring legal fees to rectify the lack of proper IP transfer agreements demonstrates the potential financial and operational burdens of neglecting this critical step.
  • Diverse IP Types and Protection: Startups must secure rights to various IP, including trade secrets, copyrights, trademarks, and patents, through written agreements to prevent loss and unauthorized use.
  • Contractor IP Ownership: Unlike employees, independent contractors retain IP ownership unless a written agreement explicitly assigns it to the company, posing a significant risk for startups.
  • Patent Limitations and Licensing: Patents provide exclusionary rights, not automatic rights to commercialize inventions, necessitating licensing agreements when overlapping patents exist.
  • Sam Champion’s Experience and Employment Agreements: TVI’s costly software ownership oversight and subsequent legal fees highlight the need for robust contract processes and clear employee IP assignment agreements, including navigating the complexities of non-competition covenants.
  • The Problem of Equal Equity: Equal equity distribution among founders, regardless of their contributions over time, can lead to unfair outcomes when some founders leave or contribute less.
  • Vesting Schedules as a Solution: Implementing vesting schedules ensures that equity is earned over time, aligning rewards with actual contributions and mitigating the risk of early departures.
  • Hypothetical Example: The hypothetical scenario with Alex, Betty, and Carl illustrates how vesting schedules would have resulted in a more equitable distribution of the company’s value, reflecting Carl’s greater effort.
  • Sam Champion’s Experience and Vesting: Sam’s failure to implement vesting schedules resulted in an unfair distribution of the buyout proceeds, highlighting the importance of aligning equity with contributions and the impact of losing control of governance.
  • The Need for Diverse Skill Sets: Technology startups require a team with diverse talents beyond the innovator’s expertise, including finance, operations, and manufacturing, to succeed.
  • The “Man with a Molecule” Fallacy: Solo entrepreneurs often underestimate the complexity of bringing a product to market, leading to frustration and burnout without a capable team.
  • Importance of Business Acumen: Technical expertise alone is insufficient; startups need individuals with business experience and negotiation skills to navigate challenges and protect their interests.
  • Sam Champion’s Experience and Team Limitations: Sam’s team, while technically skilled, lacked the necessary business and legal expertise, resulting in his inability to effectively counter investor overreach and highlighting the need for experienced legal counsel from the outset.
  • Equity and Control Dilution: Giving away excessive equity and control to early investors can hinder the company’s ability to incentivize employees and limit its operational flexibility.
  • Investor Protections vs. Founder Interests: While investor protections are necessary, they must be balanced with the long-term interests of founders and employees to ensure sustainable growth.
  • Consequences of Limited Control: Sam’s acceptance of restrictive terms from investors resulted in a loss of control, hindering his ability to pursue growth opportunities and ultimately leading to a premature acquisition.
  • Importance of Legal Expertise and Negotiation: The scene emphasizes the need for experienced legal counsel to navigate complex investment agreements and protect the company’s and founders’ interests, advising to review the appendix provided, and the resources on their website.
  • The Planning Process Matters: The creation of a business plan is more valuable than the plan itself, as it forces management to thoroughly consider goals, risks, and strategies.
  • Investor Expectations: Sophisticated investors expect to see a well-thought-out business plan, even if it’s subject to change, as it demonstrates strategic thinking.
  • Strategic Guidance: A business plan serves as a dynamic guide for strategic direction, evolving as the business grows and develops.
  • Sam Champion’s Experience and Lack of Planning: Sam’s reluctance to engage in business planning contributed to financial mismanagement and increased investor control, highlighting the importance of proactive financial and strategic planning.
  • Early Legal Intervention: Engaging an experienced business lawyer early on can prevent numerous pitfalls and mitigate risks, as advised by venture capitalists and angel investors.
  • Avoiding “Do-It-Yourself” Mistakes: Relying on generic online forms or inexperienced legal counsel can lead to costly errors and missed opportunities for strategic planning.
  • Proactive Planning vs. Reactive Solutions: Anticipating and addressing potential issues upfront, when parties are rational, is more effective than attempting to resolve conflicts after they escalate.
  • Sam Champion’s Experience and Legal Counsel Selection: Sam’s reliance on inexperienced lawyers and his “water under the bridge” attitude highlight the importance of selecting legal counsel based on relevant experience and expertise, and asking direct questions to determine their suitability.
  • The Core Principle: The most critical factor for technology startup success is unwavering focus on one or two promising near-term projects that can yield measurable success and secure further funding.
  • The “Location, Location, Location” Analogy: Just as real estate value depends on location, startup success hinges on focus, focus, focus.
  • Avoiding Broad Applicability Pitfalls: Presenting technology as broadly applicable without specific use cases deters investors, who perceive it as a science project rather than a viable business.
  • Sam Champion’s Experience and Potential: While Sam avoided this specific failure due to resource constraints, the scene suggests that greater focus and avoidance of past missteps could have led to even greater success.
  • Recap of the Top 10 Causes: The author reiterates the importance of the list of the top 10 causes of failure for technology startups, encouraging readers to use it as a checklist.
  • Resources for Further Learning: Readers are directed to the author’s website and podcast for additional resources and insights on legal issues and the technology development process.
  • Request for Reviews: The author encourages readers to leave honest reviews on Amazon to help others and promote the book.
  • Disclaimer: The author clarifies that the book is for general discussion and does not constitute legal advice, emphasizing the need for readers to seek professional legal counsel for their specific circumstances.
Appendix 1
  • Demystifying Equity Financing: The appendix aims to clarify the equity financing process for entrepreneurs by explaining the documents used by Angel investors and venture capitalists.
  • Angel Investor Documents: Angel investors typically use a Term Sheet, Stock Purchase Agreement, Investors’ Rights Agreement, and Amended and Restated Certificate of Incorporation.
  • Key Document Functions:
    • The Term Sheet outlines the basic agreement, though largely non-binding, it sets the stage for the deal.
    • The Stock Purchase Agreement formalizes the exchange of funds for stock and includes representations and warranties.
    • The Investors’ Rights Agreement grants investors specific rights, such as information access and control over share transfers.
    • The Amended and Restated Certificate of Incorporation establishes the rights and privileges of all stockholders.
  • Importance of Legal Counsel: The appendix stresses the significance of engaging experienced legal counsel to navigate these complex documents and protect the company’s and founders’ interests, especially in negotiating the term sheet and reviewing the certificate of incorporation.
  • Sophisticated Investors: Venture capital (VC) and institutional investors are highly experienced and demanding, requiring expert legal assistance for startups.
  • Standardized Documents: VCs use standardized documents developed to reduce transaction costs, establish industry norms, and provide comprehensive and consistent financing terms.
  • Key Documents and Functions:
    • The Term Sheet, Certificate of Incorporation, Stock Purchase Agreement, and Investors’ Rights Agreement are similar to those used by Angel investors but with greater detail.
    • Additional documents like the Voting Agreement, Right of First Refusal and Co-Sale Agreement, Management Rights Letter, and Indemnification Agreement address specific investor needs and regulatory requirements.
  • Importance of Early Legal Involvement: VC counsel is resistant to changes after the term sheet is signed, making early legal involvement crucial for entrepreneurs to secure favorable investment terms.

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Frequently Asked Questions

How should founders split equity?
How do I protect my idea before talking to investors?
How do I structure employee equity?
What are ‘drag-along’ rights, and why do they matter?
What are ‘right of first refusal’ clauses in startup agreements?
What is the biggest hiring mistake for startups?
What should I look for in an investor?
What happens if a co-founder leaves early?
How do I ensure my startup’s technology is protected?

How should founders split equity?

In my experience, founders who are most satisfied with their equity stakes have have discussed the split extensively. Typical topics include how much time each is willing to devote to the venture, what are the demands and the value of that work – and that’s a delicate subject – so it’s good to go out to publicly available databases to see how other companies in your industry allocate compensation generally. And it’s important to have some type of vesting provisions in place so that a founder has to stay around and keep contributing for a set period to “earn out” the initial equity he or she was given.

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