I’ve spent the last few weeks working with a start-up dot com with whom we’d been negotiating an ongoing business relationship. When we started talking to them a few months ago, they were flush with cash and working diligently toward releasing their first product.

The last two weeks have been a different situation entirely. We’ve gone from negotiating a partnership agreement to negotiating an acquisition of the company and its technology. What happened? It ran out of money.

Of course, it’s never that simple. Your company is either a dot com itself or relies on dot-com companies for services. The lessons learned from dissecting the failures of this company can be signposts for your business or warning signs in your potential partners.

Be wary of inexperienced entrepreneurs
Don’t expect a twenty-something to spend seven or eight figures wisely. The corollary to this statement is not to let technology be the sole driver in a business decision. The “idea man” in most of these dot coms is a relatively young, inexperienced businessperson with a technology idea that “everyone needs.”

You should force this technology principal to justify his or her enthusiasm for a technology with a business reason to install it. And question any proposal that shows second-year revenues greater than $100 million.

Most first-time entrepreneurs get high on OPiuM, a.k.a. “other people’s money.” In fact, my personal investment and partnership policy is to never invest in or partner with any start-up company where at least one of the founders hasn’t started a business using his or her own personal capital—charge cards, second mortgage, or family money (preferably from the in-laws—bankers can’t hold a candle to impatient in-laws).

You should also look for an experienced management team among the group of lead investors. It’s just not that hard anymore to raise several million dollars in seed capital $100K to $500K at a time, set up lavish offices, and impress clients—and then cease to exist without ever developing a product, leaving those same clients and investors stranded.

If you’re investing in a start-up or investigating a partnering relationship with one, you should perform the same level of due diligence. Know the history of its principals, its lead investor, and its financing structure. Don’t be impressed by nice offices, expensive furniture, or fancy business cards. It may simply mean the company worked with a really good real estate salesperson.

Don’t wait for the big kill
One of the classic mistakes the aforementioned company made is what I call the big kill syndrome. It went searching for the two or three killer deals that would “put it on the map.”

It expended vast amounts of capital on national advertising in an attempt to lure the prey into their lair. But when they had the chance to close, they had nothing to sell (it’s just around the corner) and no customers of any size with whom they’d proven the concept.

There are two simple ways to avoid this trap:

First: Even if you need to close the big deal to satisfy your investors, in the early days, you should focus the company on selling something regardless of the size of the deal or the company with whom you close the deal.

Having a collection of little “heads on the wall” can go a long way toward making you ready to go after the big kill. One of the most significant things you learn is whether your product or your demonstrations are actually capable of closing business.

Second: Throughout your product’s life cycle, you should have the development team focus not only on creating the product but also on creating the prototypes and demonstrations necessary to keep feeding the marketing pipeline.

Focusing solely on developing a product for release (and not developing the necessary sales tools) is a sure way to create a product for which there will be no market when you’ve completed the product. Without these tools, you never get the opportunity to allow early customer feedback to help you drive your product strategy.

Ask about the business’s capital policy
Preserving capital is important in any business, but it’s critical in the life of a start-up. The decision to lease versus buy isn’t just applicable to “hard” goods (computer hardware, office furniture, and so on). Increasingly, that decision also applies to employees and services.

It wasn’t long ago that the dot-com boom was going to last forever. Now companies are making difficult decisions about recapturing capital and managing cash flow. The company I’ve been discussing is being forced to sell more than $2 million in computer hardware for 10 to 20 cents on the dollar just to collect enough cash to pay the rent.

As the individual charged with making technology decisions, it’s important that you ask the companies with whom you’re considering a partnership about capital policy. Your decision to use one of these companies for a critical support function could cost you much more than the money you saved by using them in the first place. That’s one of the most interesting—and frustrating—paradoxes of the dot-com age.

Three questions
Whether you’re a dot-com vendor or a consumer of services from dot coms, you should ask yourself some simple questions:

  • Are you finding ways to repurpose or repackage the technology you’ve developed for new customers and markets?
  • Are prototyping and regular, brutal customer feedback part of your standard modus operandi for product development?
  • Do you participate in customer briefings with your dot-com vendors?

Is your company a dot com? What other advice would you offer for those working with dot-com vendors or in dot-com businesses? Start a discussion below.