founder stories

Startup risks that first-time founders must know

Someone has sued Eric in every startup he has ever started.

“Being sued is actually way more common than founders might expect. It's almost inevitable. As your company grows in size, you become a target for people who want to make a claim against you. Or think that there’s an opportunity to win money from your business even if you have done nothing wrong."

Oooof. That’s pretty scary.

Founders already have so much going on with scaling a business. Now they have to worry about getting sued as well?!

Before you freak out, know that there are things founders can do today to lower this risk. For this week’s episode of Uncapped Notes, Janel talked to expert Sam Hodges, founder of Vouch, on how founders can protect their precious startups.

Wait, Tam. I'm not breaking the law. What's the big deal? Why am I reading about lowering my startup risk?

Look, the things that we don’t know that we don’t know are our blind spots. And Sam has generously shared four key areas of risk that all founders should be aware of.

  1. Product risk — what happens if your product breaks?
  2. Theft and crime risk — especially digital and financial theft
  3. Stakeholders — protecting those that have invested in you
  4. Team — as you grow, team risk grows too

Sam has provided business insurance and advice to hundreds of founders on protecting their startups, even if they don’t think they don’t need to know about it yet.

So buckle up and let's break down each category so you know how to protect your precious business!

Product Risk

Eric’s first startup was an enterprise SaaS business. Customers paid hundreds of thousands of dollars to use his software product.

Now imagine if this product suddenly broke. Or performed at a level that didn’t meet his service agreement.

People would be pissed. And who knows? They might want to sue Eric. Or demand money claiming this screw-up hurt their business.

Luckily this never happened. But this possibility was definitely in the back of Eric’s mind.

At a different startup, Eric was actually involved in a breach of contract lawsuit. The language of the terms was really vague, and neither side could agree on what was being promised as part of the contract, which led to a lawsuit. Looking back, Eric believes both sides were at fault for crafting and agreeing to really bad language.

“We should have used an attorney to draft the contract, but we were bootstrapped and cheap, which led to this problem.”

TL;DR: your product falls apart and you can’t deliver what you promised. Or terms are unclear and your clients aren’t happy with your service.

Theft and Crime Risk

When I think of theft, I imagine masked bandits stealing laptops and monitors in the dark of night. But a more common occurrence is digital crime.

For example: imagine you’re a healthcare company that collects sensitive information. Your users' data is probably more valuable to hackers than any laptop.

Early-stage startups are mostly small teams with pretty limited resources. Most don’t have the time to build out a massive internal cybersecurity team that’s constantly auditing for cybercrime.

This makes early-stage startups a prime target for criminals. But VC funds are also vulnerable.

In fact, Eric knows of a fund that lost millions of dollars. A hacker successfully spoofed an email in the tone and language of their general partner. The hackers asked for a big capital call, and had the money wired directly to their account.

A less dire but still creepy example: last week, someone scraped my phone number from LinkedIn and texted me pretending to be my colleague.

TL;DR: startups need to consider the protection of their digital assets as much (or even more than) their physical assets.

Stakeholder Risk

When you are just starting out as a founder and raising your money mostly on SAFEs, the investment agreement is designed in such a way that the founders essentially have complete control over the business.

Even if the founder does something that the investors disagree with, the investor doesn't really have any rights to do anything about it legally.

However, once you raise a priced round (like a Series A), where shares are distributed to investors, you've formed a board, you've updated your operating agreement and board rights—then the situation is quite different.

Your board and shareholders have a major voice in your company and generally have a lot more legal avenues available to sue founders or make other kinds of claims.

TL;DR: contracts get more complicated as your business grows. Founders need to make sure they understand what they are agreeing to, or risk legal action.

Team Risk

In the early days, founders have time to vet early employees to make sure they’re a good fit. But as your business scales and your team grows, it’s impossible to do the same in-depth vetting.

This means the chances of a single point of failure are going to grow higher as you scale. If people are noticing you are making a lot of money, there is more incentive for poor-intent people to try to go after you for a quick buck.

There are also well-intentioned people who might make a big mistake. And the founders need to clean up the mess or do damage control. And this makes sense. Bigger team = less control = more weaknesses.

TL;DR: Serious issues will inevitably happen as your company grows. This is why it’s critical to think about having the right protection.

Ok, I’m officially freaked out

I know this article reads a bit like doom and gloom. We don’t mean to scare you - we just want to make sure you’re aware, prepared, and protected against the most common areas of risk.

So, what now?

I wanna be completely honest here. Vouch is a partner we worked with to create this content for you. We picked Vouch because we believe in their ability to help tech startups protect themselves, starting from day 1 and continuing as they scale.

Some of HF’s portfolio companies use Vouch, and if you’re considering bringing on a risk management partner, we recommend you have a chat with them.