How tech startups can deal with bad actors in their community

Starting and growing a tech company is hard. As brilliant a tech founder as you might believe yourself to be, you’ll need a team behind you to succeed; not just co-founders and staff, but great mentors, advisers and investors. It’ll likely mean parting with some shares or money along the way — good people will always need rewarding — but with the right people by your side, you’ll avoid a lot of the problems that plague young businesses, and find more opportunity for success.

Finding the right people to support you can be difficult, but it’s a task made harder by bad actors — individuals and companies offering advice or support to entrepreneurs, who are in reality either unqualified and inexperienced, or intent on putting their own interests first.

At best, a tech startup can be misdirected or misinformed, their efforts and resources can be misplaced or wasted. At worst, a founder has to wind up their business before they even launch.

Here is a brief overview of the type of challenges we’re seeing tech entrepreneurs face (illustrated with real-life examples we’re aware of) followed by practical advice for startup founders finding themselves in similar situations.

Digital agencies

Non-technical founders often get stuck on how to prove their startup idea has value. And because they can’t raise investment without some sort of proof, they’re often tempted by a digital agency offering a sweat-equity deal. That means the agency takes shares in the business — not by investing money, but by investing effort; they build a prototype for the founder in return for shares (and often cash as well).

The problem is that many agencies often demand extravagant Dragon’s Den-style percentages of equity in return for their work. In one example we’ve encountered in the North-East, a startup founder gave up 49% of their business to an agency offering to build their MVP. Another was turned down by investors because an agency had not only charged £100,000 to build their app, but insisted on 30% of the shares, too.

Tech startups can require multiple rounds of investment over time as they scale and require growth capital, in which case the founders’ original stake will be diluted several times. If the founders are too diluted before the company even launches, investors will be reluctant to get involved — that’s because investors like founders to keep hold of a healthy percentage of shares, so they remain incentivised to continue growing the business over several years.

If you don’t understand how equity and dilution works in a tech startup, this post and infographic covers the topic reasonably well.

You could argue that in the above examples, there’s ignorance on both sides of the deal— except it’s the agency that is abusing a position of trust, not the founder.

How much equity is acceptable to give away? As little as possible. Anymore than a few percent will usually raise eyebrows with investors.

There’s another fundamental issue, and that’s scope. The working practices of most agencies are at odds with how a tech startup builds a product. Agencies like briefs which are specific in terms of build and functionality; they want to build it once, and move on to the next project. But a new startup may need to iterate a dozen times or more, tweaking and changing its initial idea and execution. If the first version of a website or mobile app doesn’t hit the spot, most agencies won’t be prepared to chase a founder’s ever-moving target — at least, not without compensation.

What are the alternatives? Learning to code is the obvious answer, but there are other ways for non-technical founders to prove key assumptions about their idea — read up on the topic, learn how Ryan Hoover used email and other people’s startups to test his idea for Product Hunt, buy a copy of The Mom Test, talk to other founders (see below). You can even build a prototype of your product using Photoshop (or even Powerpoint and a screengrab tool) to design web or mobile pages, and then animate them to act like a real product with tools like Invision and Marvel.

If an agency offers to build a prototype or MVP for you:

• Ask about similar businesses they’ve worked with, and request an introduction to them (an agency that has done right by other founders should be willing to connect you);
• If the agency proposes a deal where they receive equity, ask them to explain how they think such a deal may affect future fundraising;
• Ask for their terms in writing, and seek third-party advice;
• Consider how you can prove your idea without giving away equity.

Introductions

There are plenty of people who make their name (and often, their income) from being the person in the know, a somebody who knows everybody. Because they market themselves as such, they’re often sought out by new and inexperienced founders.

It’s very rare that new founders find bad actors in their community by accident; they’re often introduced to them by somebody more visible. But visibility does not equate to experience, and it’s not unusual for some to expect a fee for helping out, especially if they offer introductions to investors.

If somebody offers to connect you with other people:

• Ask what their relationship with one another is;
• Ask why they feel the connection would be valuable;
• Ask what specific experience the connection has that is relevant to your business;
• Ask for help from your local tech community before you consider paying for it.

Advisers and NEDs

Broadly speaking, there are two types of startup adviser: informal mentors (those that offer support on a casual and ad-hoc basis, with no formal arrangement or reward for doing so); and advisers who formalise their arrangement with a startup (requiring payment or shares in the business).

There are two challenges for inexperienced founders:

• It’s difficult to know if these third parties have relevant or informed experience;
• It’s difficult to know whether they’re putting their own interests ahead of those of the startup.

And then there are the anonymous business consultants, advisers and assorted mentors who have little or no experience in the technology sector but who will look to charge hundreds, even thousands of pounds for their generic advice. Sometimes they’re legitimised by public bodies making an earnest attempt to support businesses they don’t really understand.

Here are a few real-life examples of startups we’re collectively aware of in the region, to demonstrate how badly it can go wrong:

• A tech startup had been supported by both government agencies and a number of local advisers for over a year—and yet their business was uninvestable, because the founders’ expectations and understanding of fundraising were wholly unrealistic. None of the advisers had challenged their assumptions about valuations and investment, and in fact were responsible for reinforcing bad advice.
• A team had built an MVP and were seeking investment, but 40% of their company’s shares had already been allocated to advisers and NEDs (Non-Executive Directors, or non-execs).
• An early-stage startup was strongly encouraged by advisers to pivot their business into an unrelated sector — one that happened to be of considerable interest to the advisers — and when the founders struggled with the new direction, the advisers took control of the business for a nominal amount and demoted the founders.

Some advisers will expect a fee. But it’s also common practice for a tech startup to offer equity to an adviser or NED.

There are exceptions, but as a general rule-of-thumb, unless an adviser or NED is working for your business more than a day per month, then the most equity they should receive for their role is 1%. This should always be in the form of options that are vested over a one or two-year period. This may not be the case in other sectors, but it is widely accepted best practice for technology startups.

If you’re unsure about terminology such as vesting and options, ask other tech founders who have successfully raised investment.

In return for options, there should be an agreement on the role the individual will perform. They may: support the founders in raising investment; provide business workshops to support the founders and their staff; make themselves available for a weekly call; introduce the founders to their personal network. A great adviser will do all of this.

Advisers that routinely tries to extort 5% or 10% from startups for the privilege of their face appear in an investment deck, are not only jeopardising the future success of the business, but will eventually cause word to spread about their behaviour.

If a third party wants to formalise your business relationship by becoming an advisor or non-exec, or wanting to charge a fee:

• Ask for specific examples of other companies they’ve engaged, and make a point of speaking to several of those company founders;
• Ask how and why their experience is relevant to your business;
• Ask them to clearly state their terms (in writing, so there’s no ambiguity) and seek advice.
• Agree clear objectives that you expect an adviser to meet in order to continue working with you.
• Talk to other founders and entrepreneurs to establish a baseline of what fees are and aren’t acceptable.

If an advisor is offering to invest, you should ask similar questions and always take advice from others who have been through the experience.

If you’re a tech founder…

There will always be people looking to take advantage of you.

There will always be people who are keen to offer advice, even if they don’t have any experience, or haven’t worked with a business like yours before.

You shouldn’t assume anything. Don’t assume people know what they’re talking about. Don’t assume people have your best interests at heart.

Ultimately, the person responsible for due diligence on the individuals that engage with your business, is you.

So remember this rule, because it applies at no matter what stage your company is at:

Always know who you’re dealing with.

And finally…

If you’re a first-time founder and not sure who to talk to:

• If you’re in North-East England, contact the team at Newcastle Tech Trust; as tech founders and operators, we collectively have years of relevant experience and know what best practice to follow in most situations. If we can’t help, we’ll always try to find someone we trust to;
• Get in touch with 3 or 4 established tech founders in your community, people who have already been through the experience that’s ahead of you; good founders are always happy to give back.

There’s no one way to launch and scale a successful tech startup — but there is best practice. Recognising and addressing these challenges doesn’t necessarily guarantee success, but it will mean you’re less likely to fail.