Last month, the Consultants’ Network of Northern New Jersey, part of the IEEE North Jersey Section, hosted a virtual meeting called “The Top Ten Causes of Failure for Technology Startups – And How You Can Help Your Clients Avoid Them.”
The meeting, moderated by electrical engineer and technical consultant Jay Morreale, featured Philip P. Crowley, founder and managing partner of Crowley Law LLC, a Morristown- and New York-based virtual law firm. Crowley certainly has the credentials to know what he is talking about. He was corporate counsel at Johnson & Johnson and has advised many tech and life-science companies in his legal practice. A video of the meeting can be found here.
While some of what Crowley discussed was aimed specifically at the audience of consultant engineers, many of his remarks were applicable to tech startups and midsize companies. He began by listing the 10 most important causes of tech startup failure, counting backward. NJTechWeekly.com presents them in that order below.
10. Failure to lock up the technology
That means patenting and protecting it. This is a big problem in the academic area, he said. “You have a professor who is so enamored of his technology and wants to try to develop it. … [However, academics] are really oriented towards disclosing information, not keeping the technology quiet. And so, what I have seen happen is that promising technology that might have been patented has been put into a journal article or put into a poster section of a public scientific meeting, which puts it in the public domain. This makes it ineligible for patent protection outside the United States. Inside the United States, you have a one-year grace period.”
9. Failure to set up and properly use a limited liability entity
“It’s important to avoid entering into obligations or being subject to liabilities personally. The way to accomplish this is by setting up a limited liability entity — a company that shields the founders from liability for business obligations so long as it is properly structured and operated.” Crowley added that, while many companies start as LLCs, in most cases they should be changed to corporations as soon as possible. Corporate entities provide more protection for the stockholders, so investors prefer this type of company. And, he noted, for the consultants in the audience, contracts should be between the company and any vendors and suppliers, not personally between an individual and a vendor or supplier.
8. Not having the full complement of intellectual property
“I’ve had cases where founders have retained ownership of some of the intellectual property, particularly the patents that are key to the technology of the business. When investors come in to do their due diligence, they quickly realize that the company doesn’t have all of the intellectual property it needs to succeed,” Crowley said. “The investors think, ‘If the company has slipped up on this crucial element, what else is there that I don’t know about?’ Intellectual property is the fuel that makes the business go.”
7. Not having written agreements with employees in place to ensure that everything they create at the company belongs to the company
Crowley noted that there are restrictions on these agreements in some states, but intellectual property created at a company can usually belong to the company. Written agreements are important in this regard, and employees must be made aware of their necessity. Also, it will be easier to enforce employee obligations if they have been specified in written agreements. He noted that written agreements are even more important for consultants and startups, especially when it comes to copyright protection.
As an example, he told the story of a startup that had temporarily hired the founder’s brother-in-law to write some code. After that person left, the startup made improvements in his code. When the company wanted to use the improved software, the brother-in-law pointed out that the company needed to license the code from him, since there was no agreement in writing.
6. Not dividing up equity properly
A company must have express ways of dividing up the responsibilities and equity, he said. “In a startup nobody can be responsible for everything. If they do not have a team, that can be a problem. But, in addition to having an express way of dividing up the responsibilities, dividing up the equity is an important part of the discussion that the founders need to have when they put together the venture because, unless they view themselves as equal partners with equal contributions to the venture, there may be some differences in the amount of equity that each obtains.” For instance, in many cases the CEO is awarded disproportionately more than the rest of the team because the success of the company falls on his or her head.
There may even be differences among those of equal rank. Crowley told a story about four startup founders who divided things equally and made no provisions for vesting. Three of the four founders left. The last founder worked at the startup for four more years, made improvements in the technology and even invented some new technology. When the company was sold for $10 million, however, the founder who had contributed the most still got only a quarter of the proceeds because the original agreement didn’t reward his extra contributions, and there was no vesting. “Vesting is an incredibly important element of an appropriate distribution of equity, whether it’s via grants of equity or via stock options,” Crowley said.
5. Having no team in place
Picture this, Crowley told the audience: You have just invested $2.5 million in a company that is operated solely by a Nobel laureate physicist, and you are beside yourself with joy at the opportunity. … You shake hands with the professor, and he goes outside and crosses the street and gets hit by a bus. Where did your $2.5 million go? This is an issue that investors concern themselves with when everything depends on a single inventor, and there is no team to move a project forward, Crowley said.
“In a technology business, it is clear that it takes more than one kind of expertise to be successful.” Businesses are complex, and the issues the founding team faces are very difficult to deal with, as they usually involve multiple disciplines and multiple skills. The lack of a team will also interfere with the founders’ ability to get the fuel they need, which is money from investors or, if they are lucky, non-dilutive federal Small Business Innovation Research (SBIR) grants.
4. Giving away too much of the company to some investors
“I know that certain agreements have come to the fore, including the SAFE [simple agreement for future equity], which was popularized by Y Combinator, and the KISS [Keep It Simple Security] convertible note, popularized by 500 startups, and even convertible notes themselves,” said Crowley. “It is very important to assess the long-term effects of the money that comes in. If the terms are too favorable, there is a great risk that the founders and the initial employees who are really driving the business will be unable to benefit substantially from the work they are doing to create new value in the business.”
3. Failure to put together a written business plan
“I know and we all know that every business plan is wrong. It doesn’t work. It’s not true. But it is the business planning process itself that forces founders to look at all of the aspects of their business in a critical way that doesn’t happen unless they are forced to write things down. Even if it’s wrong, a bad plan is better than no plan.”
2. Lack of an experienced business lawyer
Crowley admitted that this point could be viewed as self-serving, but he said that his VC friends thought it deserved to be number two on his list. “An experienced business lawyer can help companies anticipate problems and put in place the agreements and plans that they need in order to protect their interests and the valuable technology that they’ve created.”
1. Failure of the company management to devote its time, resources and attention to the one or two near-term opportunities that will provide the proof of concept and/or get the company to the next financing possibility
Crowley mentioned this point three times, to emphasize its importance to the success of a startup.
The rest of the meeting involved a lively Q&A period. Consultants peppered Crowley with questions and weighed in on matters such as copyright protection and what type of business plan works best (an old-fashioned business plan or the Business Model Canvas). A few of the consultants had been through the Innovation Corps (I-Corps) program, which is open to SBIR recipients, and recommended it highly.