Why Selling To The Government Can Downgrade Your Startup

Article first published as Why Selling To The Government Can Downgrade Your Startup on Technorati.

DepressionFirst Greece, now Spain and Italy. Across Europe, historically solvent sovereign governments are suffering from an acute case of systemic deficits. Now, more than ever, government agencies in the US and abroad are lousy startup customers.

I am not a government contracting expert. In fact, during my many years as an operational entrepreneur, I explicitly avoided working with governments, for the reasons described below. However, I am familiar enough with the government procurement process to know that it can result in the down grade of an unwary startup’s credit rating.

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Note: I use the term government herein as a matter of convenience to apply to all forms of municipal organizations; city, county, state and federal.

As highlighted in Negotiating With Pawn Stars, an entrepreneur’s two most valuable assets are time and money. Government customers abundantly waste both of these assets by negatively impacting a startup’s cash flows while causing it to spend unnecessary time participating in laborious approval processes and elongated sales cycles.

Some startups opt to partner with larger companies which have pre-established relationships with government customers. In the parlance of government contracting, this approach is termed a “prime and sub-prime relationship.” Although it mitigates the negative impact on a startup’s time and money, this arrangement requires the sub-prime startup to surrender a significant portion of their margin. In addition, prime contractors often jealously guard their relationship with the government buyer, which confounds the startup’s efforts to graduate from sub-prime to prime status.  

The Downside Of Government Contracting

Vendor Approval Process – In many instances, governments require companies to abide by arduous vetting processes in order to become an "approved" vendor. In the case of the US Federal Government, the steps a company must traverse to become approved by the Government Services Administration can take years and cost a small fortune of precious startup capital – time and money most startups simply cannot afford.

Slooooooow Mover – The typical government procurement process is not driven by a sense of urgency. Rather, the purchasing process is generally lengthy and requires vendors to commit significant time and resources, with no certainty that they will derive a single dollar for their efforts. Approved vendors are then required to participate in cumbersome Requests For Proposals. As noted in RIP RFPs, these voluminous documents should generally be avoided by startups, as most young companies do not have the internal resources or the luxury of time required to succeed in a multi-vendor bakeoff.

Successful startup selling is largely predicated on velocity. Thus, startups should Go For The No; quickly determine which prospects are most likely to purchase in the near term and focus your adVenture’s energy on delivering these prospective customers an awesome user experience. This is nearly impossible to quickly determine when the sales process is rigidly defined by arbitrary rules..” Indecisive prospects diffuse your focus and slow down your sales velocity. “Maybes” are much worse than quick “No’s.” Unfortunately, governments seldom do anything quickly, including telling a startup, “No.”

Slooooooow Payer – The government is a notoriously slow payer. Officially, the Prompt Payment Act requires the US government to pay its vendors in 30-days “after receipt and acceptance of material and/or services.” In actuality, payments routinely extend beyond this threshold, with 120-days outstanding not uncommon.

When the US government announced the 2009 Cash For Clunkers stimulus plan, it promised dealers they would receive payment “within 10-days.” Unfortunately, the majority of the government’s payments were not submitted until months after the dealers had paid for the used cars which they purchased on the government’s behalf. Even when the government has good intentions, it is difficult for it to act in a timely manner. Good intentions will not pay your light bill.

Capricious – Non-government customers sometimes make irrational decisions that are difficult to predict; government customers do so on a routine basis. As the decision makers come and go with the latest election cycle, a startup can lose a government account for no reason other than the newly elected officials want to give a hearty "thank you" to a company that greased the skids for them during the election. In addition, government budgets are prone to draconian, across-the-board cuts which often have no correlation to the efficacy of specific programs or vendors’ solutions. It is frustrating to lose an account to a formidable competitor. It is downright criminal to lose a hard-fought sale because of crony capitalism.

Set Asides – Despite the controls bureaucrats create to ensure a fair procurement process, it is any but. Most startups do not have the financial wherewithal to make adequate campaign contributions to purchase government set-asides or win no-bid contracts. In most cases, startups are “set aside” to make room for Big Dumb Companies (aka Big Dumb Campaign Donors), when it comes to obtaining lucrative government contracts.

Bro Factor – An inherent advantage startups enjoy is the Bro Factor. Unfortunately, this startup weapon is difficult to deploy when dealing with governments, due to the dispassionate nature of most bureaucrats. Exceptions certainly exist, but most government purchasing officers make a concerted effort to avoid developing friendly rapports with commercial vendors. More significantly, many government employees are simply not passionate about their jobs, which further complicates the Bro’ing up process, as it is difficult to create intimate, personal relationships with dispassionate, detached workers.

Mitigating Downside – Unlike the private sector, in which many buyers are focused on gaining a competitive advantage, the fear of loss is often the primary criteria motivating politicians and their appointees. As such, optimizing your company’s value proposition to satisfy the government’s low-risk threshold might result in a sub-optimal solution in the commercial arena.

High Volume / Low Margin – The combination of the low profitability of competitive bid contracts, the large size of many government procurements, and extended payment terms can be deadly for a fledging startup. Many a small business has been driven out of business attempting to satisfy a marginally profitable government contract.

The Tyranny of Low Expectations – Post sale, governments are typically undemanding customers, due to the lack of accountability in most bureaucratic organizations. Aggressive commercial customers help startups improve its value proposition with frank criticism, product roadmap suggestions and new use cases. Conversely, governments generally offer little constructive feedback.

When I was leading enterprise sales for GoToMyPC, we closed a very large deal with a municipality in Texas. The software was purchased with federal money from a “green initiative” which attempted to reduce the number of commuters. In concept, it sounded great. Commuters would use GoToMyPC to occasionally work from home, thereby reducing the number of cars on the road. In actuality, a minority of the purchased licenses where activated, resulted in a waste of tax dollars. The lack of accountability as to the program’s success doomed it from the outset, despite our diligent efforts to demonstrate GoToMyPC’s inherent value.

Lethargy Can Be Your Friend

HogsMany of the factors which make governments disadvantageous startup customers also act as competitive barriers, once a relationship is established.

Barrier To Entry – Once you are in with a government entity, the same inertia which made it difficult for you to secure the sale will make it similarly challenging for your competitors to displace you. Government programs generally continue in perpetuity, as do many of the procurement contracts which underlie these never-ending initiatives. An existing relationship also facilitates selling additional goods and services by simply amending your previously approved government contract.

Low Default Risk – Unless you are selling to Greece, Mozambique or California, the risk that you will never get paid is relatively low. The relatively slight default rate risk facilitates factoring such receivables, thereby accelerating a startup’s cash inflows. This startup financing tactic is discussed at length in Venture Debt.

Budget Drain – Government workers are trained to drain their budgets annually to avoid being granted a smaller budget in the following year. Approved vendors who enjoy an existing relationship with the government can leverage this inclination to waste money at the end of each fiscal year by pre-selling additional products and services. If the government cannot take delivery of such items by the end of their fiscal year, you can negotiate an upfront payment, which allows the bureaucrats to fully expend their budget while providing you with guaranteed future revenue and interest-free financing.

Although government customers are not without their merits, startups should only target such bureaucracies when they can obtain a market price and avoid an extended and costly sales process. By focusing on commercial enterprises that share your adVenture’s sense of urgency and profit motive, your startup can maintain its solvency and avoid a credit rating downgrade.

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John Greathouse is a Partner at Rincon Venture Partners, a venture capital firm investing in early stage, web-based businesses. Previously, John co-founded RevUpNet, a performance-based online marketing agency sold to Coull. During the prior twenty years, he held senior executive positions with several successful startups, spearheading transactions that generated more than $350 million of shareholder value, including an IPO and a multi-hundred-million-dollar acquisition.

John is a CPA and holds an M.B.A. from the Wharton School. He is a member of the University of California at Santa Barbara's Faculty where he teaches several entrepreneurial courses.

Note: All of my advice in this blog is that of a layman. I am not a lawyer and I never played one on TV. You should always assess the veracity of any third-party advice that might have far-reaching implications (be it legal, accounting, personnel, tax or otherwise) with your trusted professional of choice.

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