9 tips to avoid getting screwed by a startup
I read the article I got scammed by a Silicon Valley startup by Penny Kim this morning. It reminded me as a German entrepreneur of two startups who scammed us years ago in Munich and Berlin. Today we only work with fantastic, honest and successful startups. I want to take this article as an opprtunity to share the measures which we implemented since then to protect us and attract only good startups.
If you fool me once…
Before I start, let me briefly tell you our story. We’re a small consultancy from Frankfurt, Germany — three people back then. We pride ourselves in helping startups to get off the ground: find a market, create a business model, build a software product, recruit a team, improve. We usually leave as soon as the first revenue for our customer rolls in and the company can grow on its own. Although we also sell our services to large corporations, we naturally deal with a lot of startups.
One of these startups were a few guys from Munich, who called and asked us to help create a company on a product idea they had. Building the company to about 30 people and initial revenue took us a few months — we built business models, developed software, recruited a team and coached them. We agreed to reduce our daily rate by 50% in exchange for promised shares and gladly extended payment goals to several months. In the end they owed us almost a six figure sum, while we had huge expenses for travelling and supporting a second household in Munich. We were lucky it didn’t break our necks. Needless to say we never got any shares in the company. Today they regularily have multi-million investment rounds and still refuse to pay us our outstanding bills.
In Berlin we helped to build another startup in a different industry. Here we also did most of the initial work like business model design, software development and recruiting. Again we had agreed on a reduced daily rate and should get shares in the company. After several months and a lot of excuses, why the money was not flowing in from investors, the founder began to dispute our bills. Having learned from Munich, we stopped working earlier as the payments were held back. But it was too late: they had tricked us into working up to the initial launch press conference, so they had a working product. To this day they owe us about 70k. Theoretically we could have sued them, but their fierce lawyer plastered this route with years of law suits and five figure investments in legal costs for us — so we had to give up.
Yes, we got screwed twice in a row. Shame on us. But we definitely learned from that and thankfully have not taken on any similarily horrible customers to this day. So here is what we do differently since…
1. Don’t start working without a signed contract
As much as we would like to in many cases and as much as we know the struggles of a startup company or a guy with an idea ourselves, we refuse to do any work without a signed contract. This contract can be as simple as an offer that has been accepted by email. All that matters is that we have proof that the customer contracted us, should he dispute any bills later on. This has never been a problem with honest customers!
2. Sell an initial workshop
Before we dive deep into the business model, company structure or legacy code of a customer, we do a full day workshop. We assess the customer’s goals (ask 5 times and they will change six times!) and often already brainstorm business ideas or (depending on the type of project) create an initial backlog for development. The customer gets tangible value out of this day and we charge for it. Beside the deliverables and the great kick-off this is for a successful project, the workshop also provides proof that the customer is willing and able to pay!
3. Demand down payments
An additional way to validate a customer’s ability and willingness to pay is the down payment. Don’t be afraid to ask for a substantial part of your fixed offer or monthly bill in advance. 50% is a fair amount for a monthly bill. For large fixed price offers you can go down to 20%. But make sure that the down payment is able to roughly cover your expenses. It’s not your job to finance a customer by offering them an essential 0% credit line for 6–8 weeks! And be sure to have the money in the bank before you start working. Again this will not be a problem for honest customers.
4. Have short payment goals
We learned to keep our payment goals as short as possible. For us this means two weeks, which is by far enough time for the customer to receive the bill, pass it on to accounting, wire the money to us and have it in our bank account. In our horror scams above we had 4 week payment goals and extended those to several months readily — never do that! Keep your payment goals short.
5. Do collect immediately
It may sound harsh, but if a payment goal slips, we hand it off to a collection company immediately. Yes, we send the customer a reminder or call her first and then wait two or three days; but if no payment happens in those three days, there is no debating. We’ve learned that customers who really want to work with us and have good intentions, almost never let a payment goal slip! If they do accidentally, they correct their mistake in the three days extra time we grant them. The only customers not honoring your payment goals and coming up with all kinds of excuses are those who were planning to scam you anyway!
6. Stop working immediately
No money, no work. If a customer let’s the payment goal slip, we stop working on the spot. No debating, no whining about deadlines or the „practically already signed million euros investment contract“. We are not mean people, we just learned the hard way. Halting work immediately not only saves you from doing work for free, but it also puts immediate pressure on your customer to pay you. Should the customer face bankruptcy (often knowing without telling anyone, which is technically illegal), you will have a higher chance to see some money. Again, startups who don’t mean to scam you, but simply run out of funds will not cover up looming bankruptcy and will understand you halting your work.
7. Don’t reduce your rate in exchange for shares
Even with startup clients who are honest, getting paid in shares can be a bad idea (see Brennan Dunn’s article). But for morally misguided people, this would open all doors to scam you. In fact, we still do shares for reduced rate deals occasionally. But: you should always make sure that the reduced rate alone will cover your expenses and your salary! View the shares as something of zero value. If you can live with that, then you can take shares for a reduced rate.
8. Trust your instincts
We’re rational tech and business people. Still you should learn to trust your instinctive feelings with a customer. If it somehow doesn’t feel right, don’t do business with them. Life is too short and there are too many other customers out there needing your services.
9. Don’t be afraid to lose customers
With all these mean looking tips you might be afraid to scare potential customers away and lose projects. Yes, you have to be prepared to lose projects, because certain customers might avoid you. But from our experience, you only loose the bad customers, while the honest and sincere startups will stay. It takes some courage to leave money on the table, but it pays in the long run.
Despite (or maybe because) following all these tips, we have better relationships with our customers today than we had a few years ago. And might I say, we have fantastic customers and are motivated every day to deliver extrodinary value to them.
Also treat the people who work for you well: don’t let payments slip, don’t try to negotiate unfair terms. If you treat your employees and contractors well, you will have a happier and more prosperous business.
We learned some lessons the hard way. I hope our experiences and the 9 tips from this article can protect you from similar fate. Now go out, do some awesome work and create success for the many great, honest and sincere startup companies out there!