
A Classic Startup Horror Story - t3mp3st
http://venturebeat.com/2012/02/27/a-classic-startup-horror-story-the-ma-bait-and-switch/2/
======
pg
This sort of scenario is unfortunately very common. The antidote is never to
allow acquisition talks to be the main thing you're focusing on. We advise
startups who get approached by acquirers to treat it as a background process,
and not to take things seriously until the very last stage. If acquisition
discussions are just a side show, you can easily terminate them if anything
goes wrong. Which, interestingly, probably decreases the chances of things
going wrong. M&A guys can smell it when you really want a deal, and that makes
them want it less.

~~~
saturdayplace
> M&A guys can smell it when you really want a deal, and that makes them want
> it less.

This seems perverse, but I'm guessing that there's some kind of economic
intuition these guys have gained from being around deals all the time?
Something like, "Wants a deal == needs it == a bad investment." This just
seems to confirm that the best way to get money thrown at you is to not have a
need for it.

~~~
nostrademons
I was out with an investment banker at a social outing, and I asked him
"What's the biggest mistake startups make during the acquisition process?" He
said, "Buddying up with their potential acquirer. Once you express strong
interest in getting bought, you've just lost all negotiating leverage. You've
got to play coy with potential acquirers until the deal is signed."

~~~
larrys
"Once you express strong interest in getting bought, you've just lost all
negotiating leverage. "

Sure if you maintain that strong stance. But you can always change your level
of interest and the opposite party will sense that and run to fix the deal.
It's a game of chicken at that point but here's the thing. The acquirer is
only looking at you and has decided they want what you have. If they didn't
they wouldn't be attempting the acquisition.

So look as eager as you want. And then stop being prompt and act as if
something else is going on and watch and see what happens. The investment
banker doesn't want to loose a deal.

~~~
lix2333
I work in an investment bank and I'm not sure how much power the banker has in
the deal process. A lot of it is dependent on the buyer, less on the banker.
Bankers get paid based on the size of the deal. We usually take 2-3% of the
transaction, but if the deal is huge, you might see that number fall down to
1% or so. Usually, its the buyer that hesitates and decides not to buy it. The
banker would usually try to get the firm to purchase it, so they can get paid
the commission.

------
dctoedt
All is not lost, and the start-up shouldn't despair, for a couple of reasons:

1\. It's not unknown for acquisition deals to get put on the back burner for a
while, even a year or two. That happened to my former company when it was
acquired. (This history was publicly disclosed in my company's proxy filing
with the SEC [1].)

2\. The Company's lawyers are likely to tell them, forcefully, to be very
careful about trying to redevelop the technology, precisely because of the
NDA.

Suppose that The Company didn't use completely different people (a "clean
room" approach) to redevelop the technology. In that case, a jury might not
believe they really did it independently.

In a somewhat-similar situation in the mid-1990s, Rockwell International got
tagged by a jury for almost $58 million for breach of an NDA with a small
start-up company concerning circuitry for improving data transmission rates
over analog cell phones. (Disclosure: I was co-counsel for Rockwell at the
trial.) [1]

(To be sure, The Company's engineers and executives might well convince
themselves that they really did redevelop the technology independently,
without using the start-up's confidential information. That could make it
difficult to settle the case: The important decision makers might sincerely
believe The Company didn't do anything wrong.)

[1] [http://google.brand.edgar-
online.com/displayfilinginfo.aspx?...](http://google.brand.edgar-
online.com/displayfilinginfo.aspx?FilingID=4002636-972-537833&type=sect&TabIndex=2&companyid=5687&ppu=%252fdefault.aspx%253fcompanyid%253d5687)

[2] Celeritas v. Rockwell,
[http://www.ll.georgetown.edu/federal/judicial/fed/opinions/9...](http://www.ll.georgetown.edu/federal/judicial/fed/opinions/97opinions/97-1512.html)

[edited]

~~~
ww520
Yes. The startup might not have the fund to enforce NDA now but wait until the
Company has developed a similar product. There will be lawyers willing to do
Pro Bono on collecting the damage.

~~~
hga
Bingo. A major use of these sorts of agreements is "If you cheat us AND make a
bundle 'we'll be back'".

Or at least that threat WRT employees unwise enough to have signed non-
competes (Boston and D.C. areas, obviously not California) has killed several
situations I've been in where a company failed and dog in the manger types,
the very ones responsible for the failure, used such threats that everyone
else gave up and the concept and/or technology died a hard death.

------
mekoka
_We are a company without the cash to try to enforce the NDA_

Then why disclose your trade secrets under such terms in the first place?

On busy streets, I sometimes see an attitude amongst pedestrians, who like to
casually jump in front of cars as soon as their light turns green. Their
thinking is that _they have the right to cross_. There's a sense that drivers
are under pressure _by law_ to keep you safe, otherwise they'll be in trouble
and people tend to mistake that as some sort of immunisation against
accidents.

But what if you get hit? Is the law going to give you back your legs?

I think the valuable lesson here is that, even if the law protects you and
provided you can afford it, there's no substitute for prudence.

~~~
dmbaggett
No corporate development person is going to take a deal to the CEO without
having gone through dilligence. So as the selling party, you're forced to
subject yourself to this kind of process.

However, you don't have to actually answer everything you're asked in this
financial (and technical) cavity search. In one M&A process I participated in,
the buyer asked the seller to "tell us your strategic vulnerabilities: if
someone wanted to totally shut you down via technical, legal, or data means,
how could they do it?" The sellers politely refused to answer this.

Bottom line: there are no rules, and it often seems no one feels any shame
doing the most utterly awful, unbelievable things during these M&A processes.
NDA's don't mean jack, and if you don't answer enough of the questions, they
simply cannot buy you. Choosing which questions to answer, and walking away
from all the others, is key.

And, as another commenter said: don't ever _need_ to sell. If you really need
to sell, you're probably already doomed.

------
gyardley
This is also a classic bigger-company horror story -- when the developers who
said "this isn't so hard, we can do it ourselves" start working on it and run
into all the tiny little gotchas that aren't evident in due diligence.

Maybe I've just been exposed to a weird sample, but I've heard 'we can do it
ourselves' at least a half-dozen times over my career and not once has anyone
actually done it themselves.

~~~
mkramlich
That suggests what might be a good rule of thumb for distinguishing a rock
star programmer from the other kind. The rock star says they can do it, and
mean it. Then they do it. Done.

~~~
j_baker
...or the rockstar says they can't do it, and mean it. Then they don't do it.
Not done.

~~~
tbsdy
Or the rockstar programmer says it can't be done, then he does it. And the big
company looks at it and ignores it.

------
jpdoctor
> _“If you agree to these terms, we have a gentlemen’s agreement that you’ll
> stop talking to other companies?” ... We agreed._

It turns out that's an intelligence test: Anybody worth having a gentlemen's
agreement with would be gentlemenly enough to put it down in writing.

The correct answer is: Put it in writing.

Edit: NDA's are another intelligence test btw. All of the entanglements
without any of the enforceability.

~~~
jonny_eh
So you're intelligent if you don't demand an NDA?

~~~
jpdoctor
Not quite. It's more like: You're not intelligent if you think an NDA is worth
a damn (as the article shows.)

~~~
cturner
When good people sign a NDA it counts for something.

When you're dealing with lying buggers though, it represents an option to sue.
Insurance is similar.

~~~
S4M
Yeah, except when you are not in position to enforce the NDA which was the
case of the OP.

~~~
jacques_chester
Many lawyers will take cases on contingency.

ie, they'll work for a percentage of any payout.

~~~
nknight
Yes, but that doesn't always help.

If your opponent is rich, they can hire an army of lawyers, and you'll
generally need a correspondingly huge law firm prepared to invest their own
time and money in countering that. The kind of law firms we're talking about
are both few in number, and generally fully-engaged by well-paying clients --
clients like your rich opponent. The incentive to take on a case like this is
pretty limited.

~~~
vlisivka
Army of lawyers may cost much more than NDA. :-)

------
casca
Something doesn't smell right with this story. If a big company clearly breaks
a contract, there's money to be had and the lawyers will work on retainer.
NDAs are legal agreements. They can include terms that prohibit the creation
of a similar product for a length of time.

My favourite snippits are: "We shipped some amazing new products" and "Our
systems handle load today that they wouldn’t project to have until 5 years
from now, all on a minuscule startup budget". Shipping is easy. Selling is
hard. And building something that scales to (optimistic) 5-year (!) projects
seems like premature optimsation to me.

~~~
sowbug
It's possible the CEO didn't mean that his company intended to copy the
technology, but rather that it would be easy to copy it, and thus that it
wasn't worth anywhere near the figures being tossed around. In that case, this
wouldn't have anything to do with enforcing an NDA; it would simply mean the
parties disagreed on the value of the technology and couldn't reach a deal for
that reason.

The article didn't say whether the other company actually did try to copy it,
which is why "It doesn't look so hard, we can build it ourselves" is at least
a little ambiguous -- especially because it's unlikely that's a direct quote
(might "can" have been "could"?).

------
goatforce5
Worked for a start up that was in an extremely long period of due diligence
with a big company you've heard of. The big company was giving our company
money to meet payroll, so they knew our piggy bank was empty.

Big company says thanks but no thanks. We all get laid off by the start up at
lunch time. That afternoon our company lets it be known that they'll be filing
a law suit asking for damages of a billion dollars (a similar company had
recently sold for several hundred million and it was the dotcom boom days - a
billion sounded not entirely insane).

Big company has a change of heart late that night and decides to buy us for
tens of millions of dollars. People called and told to come in to the office
in the morning - the day had been saved!

The next morning everyone was fired by big company and the little startup was
shut down. Ooops.

~~~
hga
Errr, where's the oops?

Sounds like the big company really didn't want to buy and that was the
definitive end of the startup, but after the threat of the lawsuit either
_someone_ got paid 8 figures presumably to avoid the lawsuit or the big
company reneged on the payment, at which point no one is any worse off.

------
espinchi
The key for a successful negotiation is to have leverage. In this particular
case, it looks as if the founder of this startup needed the acquisition to
happen. Otherwise, when The Company refused the official term sheet, or when
they noticed any other smelly things down the road, they could've halted until
that detail was sorted out, or even canceled the negotiations.

The conclusion in the last paragraph of the (highly enjoyable, btw) story goes
in this direction, but it's a bit optimistic: _the real lesson learned is
this: get your business to a level of success where you don’t care if the deal
falls through. Get profitable. Get such amazing user growth you have investors
begging to put in money_. Well, I wish it was that easy!

------
patio11
This happens all the time, even for acquisitions which _eventually succeed_.
Eric Sink sold his company to Microsoft and mentioned at the BoS 2010
conference that the deal status was "Totally dead: neither party will take any
more action regarding this opportunity" two separate times prior to them
finally doing it.

------
j_baker
You know, I started to get suspicious around the time I read the phrase
"gentleman's agreement". I can't think of any _good_ motivation a person could
have for wanting such a thing aside from the fact that the lawyers haven't
drawn up a contract yet.

------
joedev
That's not a classic "Startup" horror story. That's a classic "Built to Flip"
horror story. One of many reasons why selling is not an desireable business-
model strategy.

~~~
j_baker
There are reasons to sell a startup aside from having built it to flip. It can
even happen in a startup that the founders had every intention of building
into a big sustainable business. Many times, it's because the founders and/or
investors have "checked out" of the business and want a quick return on their
time.

------
onemoreact
_If you agree to these terms, we have a gentlemen’s agreement that you’ll stop
talking to other companies?_

Hint: This is when you say I can do that for X months in exchange for Y
breakup fee if this deal falls though.

PS: You can still increase Breakup fee's later in the process, but this is
little reason to stop talking to stop considering other offers without being
paid to do so.

------
cienrak
I don't understand why they didn't try to fight this based on the NDA or no-
use. Wouldn't a good lawyer be willing to take this on retainer, if they could
prove their tech was being ripped off despite the legal protections they
signed going into the deal?

~~~
true_religion
I'm having trouble following... how were they ripped off?

There's some confusion about the NDA, but as far as I can see... The Company
didn't disclose to anyone.

It broke down in due diligence which could just mean that The Company looked
at their financials, and found that they were a lot weaker than first presumed
and thus not a good acquisition. I'm not sure they admitted that they weren't
profitable (who does really?), so it might have been presumed that if you have
X products, and Y infrastructure then you must have Z sales behind it. When
they looked at the financials, they didn't see the sales figure they wanted so
bailed.

~~~
karamazov
NDA's are normally written not only to prevent disclosure, but also to prevent
the company receiving the information from using it to copy your product. If
you're disclosing to a potential competitor, you don't want them sharing that
information with anyone else, but you especially don't want them just stealing
your codebase and using it themselves.

~~~
dmethvin
I went through this very same left-at-the-altar scenario a decade ago with a
startup. It can be _very_ difficult to prove that the company used the NDA
information they had in their possession. Clearly the tech staff in the big
company saw it, since this seems to be how they made the determination that
they could do it in-house for less.

------
rokhayakebe
Dude, seriously, this isn't helping anyone unless you give some clues allowing
people to figure out who The Company is.

~~~
archangel_one
Actually, I think the general lessons can be learned regardless. Naming The
Company would turn it into mudslinging which would change the tone of the
article, and IMO probably not for the better.

~~~
TDL
Agreed. The general case is much better in this regard. The drama from knowing
who the players were would distract from the events and any lessons learned.

------
sriramk
There's a non-zero possibility that the engineering org did report back to the
CEO that they could build it.

I've many a large company M&A scuttled due to NIH syndrome from engineering.
And almost always they massively underestimated the effort needed to build
something (including whether they had the talent or not).

I know of atleast one case where it has resulted in long term serious
strategic harm for BigCo when they refused to do a small acquisition (single
digit seven figures) because of exactly this scenario.

~~~
georgemcbay
The whole engineering/NIH/underestimate situation certainly rings true.

OTOH, there also tends to be a vast underestimate on how difficult it will be
to integrate an existing product (even if it is already built) into a new
company.

It is extremely rare that a product the company is acquiring for is exactly
the product they need, it is usually 90% of the product they need, and they're
still going to have to get the second 90% done while simultaneously working on
all the culture issues that pop up when trying to bring two companies
together.

------
alan_cx
OK, I dont know much about start ups (I lurk here because of the quality of
stories and comment), but here in the UK what I see often are start-ups who
seem to rely on the idea that they will run at a loss, often large loss, in
the expectation that they will either float or get bought up, rather than
perusing a model where the start-up can be profitable on it's own. I've worked
for a couple during ye olde dot com boom!!!

OK, I understand that model and I can see the sense in it, but does it not set
up a situation where the start-up is so dependent on some one buying them up
that they can get over keen once potential buyers circle, resulting in them
becoming vulnerable to the iffy behaviour of bigger businesses.

Seems to be a critical point in the business, where the founders can run in to
trouble, for reasonable human reasons. Perhaps some sort of help is required
in this area?

------
mcgwiz
The submitted link goes to the second page of the article. Here's the first
page: [http://venturebeat.com/2012/02/27/a-classic-startup-
horror-s...](http://venturebeat.com/2012/02/27/a-classic-startup-horror-story-
the-ma-bait-and-switch/)

------
brooknam
Having seen a startup in Austin, TX go through this same kind of thing, I
would guess its more common than the author makes it sound here.

The best defense is to build a technology that isn't cheap to reproduce. There
is no better moat than killer IP.

~~~
AznHisoka
This is not practical advice. Not many people here are building the cure to
cancer. The best defense is to build a self-sustaining business where you
don't need to sell it.

~~~
wyclif
This is true. The classic example IMO is Amazon: they didn't have "killer IP."
Their "moat" was their mastery of fulfillment and distribution, and owning all
the links in that chain.

------
outside1234
if you want it to not happen again, you have to name names. otherwise, there's
no downside to this company.

~~~
mcdavis
Any downside for the company would be so short-lived it wouldn't be worth it.
Like most ragefests, it'd die down at the next controversy and be forgotten.

They're not naming names because they value the lesson more than the temporary
shaming.

~~~
propercoil
not if you are GoDaddy.. SOPA sticks like a mother f'er

------
pconf
All good reasons for NOT sharing your startup's IP with prospective partners,
not with their CEO, not with anyone.

This story could have been written about GO's negotiations with Microsoft
almost 2 decades ago. When MS shined-on GO their lead in the tablet market,
and many, many jobs, were lost.

We must remember that large Corporations are looking out for their own
interests in ALL cases, recognize when they would benefit by putting us little
guys out of business, and act accordingly. If they won't buy us without a
detailed look at our IP so be it.

------
commanda
Luckily, the acquiree knows that "It doesn't look so hard, we can build it
ourselves" is almost certainly a mistaken belief on the part of the acquirer.
I've found that any system, no matter how complicated, when explained by a
competent engineer who knows the system well and is a good communicator,
sounds "not so hard, I could build it myself". I have to remind myself that it
is probably hard, and I could probably not build it myself for less than the
cost of the acquisition.

------
autarch
This link goes to the second page of a two page story.

