From the Harvard Law School Program on Negotiation titled “Conflict Management From the Start“:

After reaching an agreement, professionals often rely on their lawyers to draw up the official contract. Unfortunately, miscommunication between negotiators and their lawyers often leads to costly mistakes. Contract terms may not accurately represent the negotiated agreement, key deal terms could be missing, or clauses might contradict one another.

The biggest miscommunications happen when the lawyers don’t have a term sheet to work from. If you just give them a summary, some e-mails, and perhaps the other party’s standard contract, they have no idea what to do with it. What follows are a long series of questions and back-and-forth on the contract terms. All of which could have been avoided if they’d had something more structured to work with from the beginning.

I’ve done it both ways. A term sheet is always the better, faster way to go. The legal process takes far less time, you end up with a contract that covers what you expected, and you don’t get blind-sided by anything 6 months into the deal.

You can equate not using a term sheet to trying to launch a new product without having detailed written requirements. That too doesn’t work so well. Take the time to write everything out and gain agreement on it. You will be glad you did.

He presents a useful model for determining whether or not free is right for your product.

The thing I found most interesting was the concept of “the penny gap.” I hadn’t heard this before.

“The penny gap”—the hardest part is to get your customer to pay you the first penny. This is why it is so critical to choose your premium features wisely.

Also of note is the idea that the costs for most online products will trend towards free.

…Because of declining hosting and bandwidth costs, for most Internet products the marginal cost today is practically … zero.

In other words, if the cost to serve a customer (support aside) is zero, the long-term price of the product in the market will be zero (because of competitive pressure).

Check out the post, it’s very thought provoking.

I spent 6 years in business development working for 2 large, established players. One of my many responsibilities was evaluating unsolicited, incoming partnership opportunities. While I had never heard the term “ham and egging” referenced in Dana’s post, I experienced it on a regular basis. She describes it as:

…”ham and egging” was first coined by Columbia’s professor Amar Bhide and Harvard Business School’s Howard Stevenson. The term refers to the technique of convincing multiple stakeholders that others are working with you despite the fact that you’re only in talks. The only problem is that most early partners only want to work with you if other reputable partners have already signed on.

Explains Bhide and Stevenson,”the ultimate ham and egging solution is for the entrepreneur to simultaneously convince each participant that everyone else is on board, or almost on board.”

It seemed like most startups attempted to use this approach. Fortunately I knew all about it. I had seen this from the inside in prior years working at multiple startups (I was not in business development roles at these startups). This technique was specifically discussed and planned. There were other tricks, but I’ll get to those later.

It’s amazing how many people at large companies take these claims at face value. I often had to remind my peers and superiors that just because someone says they’re working with a major player doesn’t mean they are. That leaving a voicemail or sending an e-mail for someone at Google doesn’t mean that they’re “in partnership discussions” with these companies. If it’s not announced or if they don’t have a reference, then it doesn’t exist.

My point here isn’t to imply that startups are shady, though some are. My point is that you can’t always take things at face value. People at startups (especially the founders) believe in what they are doing. Many truly believe that they will eventually have the deal that they talked about. They believe that their product will do what they say it will, even though it isn’t built yet. They believe that they’ll eventually have the traffic they are promising. They just need that first deal to get it all going. The problem is that most big companies are not able to take a risk on a partner that hasn’t already proven their product. So startups are in a tough position.

Here are the tricks that I frequently saw startups using:

1) Ham and egging (as explained above). If there’s no partnership announcement or reference, then you should be skeptical.

2) Exaggerating revenue, subscribers, user base, unique visitors, etc. If they won’t show you actual traffic logs or put numbers in writing, then you should be skeptical. Confidentiality is not an excuse for not providing this information.

3) Exaggerating product capabilities. If they don’t have a fully functioning demo or don’t have it in operation with another partner,then you should be skeptical. You should insist on sending up an engineer to check out their operations.

4) “We’re going to be in town anyway, so we might as well meet in person for a demonstration.” This one always makes me laugh. While not terribly sleazy, it is annoying. I was in Dallas. No one is in Dallas “anyway” (at least not very often). I heard this from well over half of the startups trying to get in the door with us. This means I’ve literally heard this over 100 times. Don’t be pressured into wasting your time and that of your management team to meet with someone where there is no real opportunity just because “they’re going to be in town anyway.” If they tell you they’re going to be in town anyway the week of X and then tell you they can meet with you at anytime, then you know they’re lying. They should at least have the intelligence to block out a few time slots so it looks like they actually have some meetings.

Having said all of this, I did a lot of deals with startups and most of them worked out OK. The key is due diligence beyond that needed for larger potential partners. Hopefully this will help you in your future dealings with startups.