Why Selling To The Government Can Destroy Your Startup

Maya Angelou Forever Stamp Dedication

A version of this article previously appeared on Forbes.

The US Postal Service pulled off another debacle with the Maya Angelou stamp. Their task was simple. Combine a photo of Ms. Angelou with one of her more memorable verses. Instead, the coupled her image with text written by Joan Walsh Anglund.

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Twice Isn’t Charming

Hey, everyone makes a mistake. Surely this is an anomaly for the always-on-the-brink-of-insolvency US Postal Service (USPS). Sadly, this is not the case.

In 2010, as part of its “Forever” series, the USPS issued a stamp of the statue of liberty. However, rather than using the statue which has greeted immigrants to the US for nearly 135-years, the USPS erroneously used a photo of the cheesy replica which sits outside of the New York, New York hotel in Las Vegas.

After first denying it had made a mistake, the USPS was sued by the sculpture of the Vegas replica for copyright infringement. Oops.

Note: As a public service, I will happily offer the USPS a 15-minute course in “How To Use Google” at my special government rate of $150,000.

The Downside Of Government Contracting

The abundance of incompetence and the utter lack of accountability are just two reasons why startups should avoid selling to the government. Even in the USPS’s response, they took little ownership for their obvious error, stating “Had we known about this issue beforehand, we would have used one of [Ms. Angelous’] many other works.” In other words, “if we had known it was a mistake, we wouldn’t have done it.” Wow. This childish response in the private sector would almost certainly precede an employee’s brisk walk to the door with their belongings in a box.

An entrepreneur’s two most valuable assets are time and money. Government prospects abundantly waste both, by negatively impacting a startup’s cash flows while causing it to spend unnecessary time participating in laborious approval processes and elongated sales cycles. 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.

Other reasons startups should avoid engaging selling to the government include:

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 requirements of the Government Services Administration can take years and a small fortune to fulfill – time and money most startups simply cannot afford.

Slooooooow Mover – Given the typical government worker’s lack of accountability, the typical government procurement embodies no 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 complete cumbersome Requests For Proposals. 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 venture’s energy on delivering near-term prospects an awesome experience. 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 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 companies, when it comes to obtaining lucrative government contracts.

Bro Factor – An inherent advantage startups enjoy is the Bro Factor, 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.

The Tyranny Of Low Expectations – Post sale, governments are typically undemanding customers, due to their “lack of accountability” culture. In contrast, aggressive private sector customers help a startup improve its value proposition with frank criticism, product roadmap suggestions and new use cases.

A Middle Ground

Some startups avoid some of the pitfalls of selling to the government by partnering 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 this approach mitigates the negative impact on a startup’s time and money, it 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.

Lethargy Can Be Your Friend

Many of the factors which make governments disadvantageous startup customers also act as competitive barriers, once a relationship is established. As your company grows, it might make sense to seek government contacts, for the following reasons:

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. All too often, government programs 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.

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 venture’s sense of urgency and profit motive, your startup can maintain its solvency and avoid getting caught up in the government’s next outrageous mistake.

Follow my startup-oriented Twitter feed here: @johngreathouse. I promise I will never tweet you about politics or that killer burrito I just ate.

Image: Leigh Vogel / WireImage

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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