ConTraps Part II – Contract Traps Entrepreneurs Should Avoid At All Costs

Note: This is part II of a four part series. Access part I HERE, part III HERE, and part IV HERE.

ConTrapsAs noted in part I of this series, agreements with Big Dumb Companies (BDCs) can be alluring and potentially fatal. In many cases, agreements crafted by BDC lawyers resemble ConTraps rather than mutually beneficial contracts.

This series describes how entrepreneurs can craft company-changing agreements with BDCs, while avoiding Kiss of Death contract provisions.

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Kiss of Death ConTraps

Entrepreneurs should never agree to the following provisions when negotiating with a BDC, no matter how lucrative the potential relationship. Part I makes it clear that in order to avoid these potential legal tripwires, entrepreneurs must draft the initial iteration of all their key agreements. As you do so, be sure to cover your tracks and do not leave behind tell-tell clues as to your underlying negotiating strategy, as described in Backmasking.

Part I

  • Allow the Other Side to Draft the Agreement
  • Deploy a Free Pilot
  • Cut a Multi-year Agreement
  • Lock Down the Escape Hatches

Part II

  • Give up Branding
  • Relinquish Press Release Capabilities
  • Approve Unilateral Provisions
  • Surrender Arbitration
  • Accept Unlimited Liability
  • Forgo Change of Control or Agree to a ROFO or ROFR

Part III

  • Serve up World-wide Distribution
  • Relinquish Joint Intellectual Property Rights
  • Execute an Ambiguous Statement of Work
  • Agree to Bundling Without a Minimum Price
  • Grant Most Favored Nations Status
  • Issue Unmitigated Exclusivity

Part IV addresses:

  • Issue Unmitigated Exclusivity

 

Yahoo Powered by GoogleDo Not Give up Branding

BDCs often ask to “private label” or “white label” a smaller company’s technology.  This generally involves the BDC selling the startup’s technology under the BDC’s brand. Do not allow your adVenture’s technology to be buried in the bowels of another company’s product, without reasonable attribution.

As shown at left, Google’s initial go-to-market strategy included syndication of its search capabilities to third-party sites, including Yahoo and AOL. In each instance, it was noted that the search was “Powered By Google” – even though many people at the time were not aware of Google’s brand. This brand exposure helped Google establish “www.google.com” as a leading destination site.

As described in PR Passion, your adVenture should maximize any and all third-party points of validation. Thus, demand “Powered By” branding status to ensure that end-users will be exposed to your brand and alerted to the fact that your technology is a significant component of the BDC’s solution. The resulting credibility will help you establish future business development and customer relationships.

Your pitch will be far more compelling to prospective customers and business partners when you have physical evidence of your partnership with a BDC. When establishing GoToMyPC partnerships, I was able to direct a potential partner to an existing partner’s website and show them our “Powered By” branding status. If I had been forced to say, “I know you cannot see it, but our technology is the engine behind Gateway’s support solution,” my ability to establish new partnerships would have been hampered.

To control the specific amount of brand exposure you will derive from “Powered By” relationships, create graphical examples of how your “Powered By” status will be communicated on the partner’s site, products, brochures, point-of-sale displays, etc. You should also specify the minimum font size in each medium your brand will be displayed. In order to ensure that these specifications are honored, include the “Powered By” samples in an exhibit to the partnership agreement.

I never lost a deal by remaining steadfast on this issue, although some BDCs blustered considerably. If your Bro Foe believes that your technology represents a compelling value to their customers, they will grant you “Powered By” branding status.

Do Not Relinquish Press Release Capabilities

Every BDC has been burned at one time or another by a jackball entrepreneur who publicly misrepresented the nature and scope of his or her relationship with the BDC. Such misrepresentations embarrass the BDC executives and confuse the market.

Due to their aversion to being publicly humiliated, most BDC partners will attempt to preclude you from issuing any unilateral press releases. Some will even try to prohibit you from issuing any public statements related to your relationship. With this in mind, in your initial draft of the agreement, request the right to issue a unilateral press release, as long as it is first reviewed and approved by the partner. If the BDC has a chance to review and approve the language in advance, it will be more difficult for them to make a reasonable argument that you should be precluded from issuing such a release.

A unilateral press release is less threatening to the partner, as it is solely issued by your firm and not publicly sanctioned by the BDC. As such, it will not be viewed by the market as an explicit validation of your technology. It will also receive limited media coverage, thereby further reducing the BDC’s risk. See Thrill The Messenger for tips regarding how to maximize the impact of Partner press releases.

In some cases, the credibility generated by your association with a BDC is the most valuable aspect of the relationship. This is especially true when the BDC grinds you down on the financial terms. In such instances, the level of public relations autonomy you negotiate might dictate the ultimate value derived from the relationship.

To maximize the value of such financially neutral partnerships, make it clear at the outset that you expect to have reasonable autonomy with regard to your press releases. If you wait too long to communicate the importance of obtaining public validation, you may negotiate a deal with marginally acceptable financial terms and be unable to leverage your association with the BDC.

I have been successful in obtaining some level of public relations exposure in the large majority of my BDC partnerships. However, despite the limited risk poised by a unilateral press release, some BDCs will not budge on this issue. If you find yourself dealing with such an organization, omit all references to press releases in the agreement. As every entrepreneur knows, it is easier to beg for forgiveness than it is to ask permission.

Do Not Approve Unilateral Provisions

What is good for the goose is good for the gander. Often, a BDC will attempt to force your startup to accept language that is not quid pro quo. This is almost never a reasonable request. For instance, the BDC may ask you to indemnify everyone under the sun on their side (e.g., employees, officers, shareholders, etc.) for every eventuality, while they will refuse to offer you indemnification for anything other than fraud or gross negligence. Such a concession essentially offers you nothing, as common law protects you against such illegal acts.

If there is not a valid business reason for granting one-sided terms, reject the language on the grounds that it is patently unfair. It is healthy for both parties to maintain symmetry in as many of the non-deal specific terms as possible, as it reduces potential confusion and establishes a collaborative tone to your relationship.

As noted in part I of this series, if you allow the BDC to prepare the initial draft of the agreement, it will likely be fraught with one-sided language that you will be forced to negotiate and thus needlessly spend your negotiation capital to simply return to a reasonable starting position. If the BDC demands the inclusion of one-sided terms, either reject them out-of-hand or accept them in bi-lateral form. If you accept unilateral terms, you risk becoming a Corporate Beyotch.

Do Not Surrender Arbitration

BDCs have legions of lawyers who trudge into work each day, whether they have something to do or not. Avoid giving them something to do, as the less involvement you have with BDC lawyers, the better.
One way to reduce your risk of litigation is to require that all disputes must first be addressed via a cure period in which the party that is “wronged” must notify the other party, who then has a prescribed time period to rectify the issue.

If the cure period is unsuccessful in satisfying the “wronged” party, the issue should then be addressed via a mutually agreed upon member in good standing of the American Arbitration Association. In addition, specify that the loser of such arbitration proceedings must pay all of the associated costs, including reasonable legal fees. Arbitration procedures are less time consuming and far less costly than arguing your case in court.

Do Not Accept Unlimited Liability

Another common unilateral provision is one in which a BDC proposes to limit the scope of its damages with a de facto financial cap while leaving your liability open-ended. This request arises from the BDC’s desire to mitigate the risk that you will request compensation associated with lost profits if the deal falls apart. This a valid concern because the courts often side with the smaller company when damages result from a failed relationship. Thus, most BDCs attempt to explicitly preclude any such open-ended damages.

Your goal is to maximize your upside – their goal is to minimize their downside. With this knowledge, craft a deal that allows both parties to attain their respective goals. In the Indemnification Section of the agreement, place a de facto limit on the amount of expenses to be paid by both parties in the event damages arise.

Trade this concession for a reasonable cap related to your damages. Do not accept language that limits damages to “total fees paid by the BDC during the term of the agreement.” If a deal unravels before substantial fees are generated, you may end up in the disadvantageous position of being unable to recoup your opportunity costs.

As such, opt for a provision that specifies a cap equal to, “(i) the greater of $__________ (a de facto minimum amount which covers your costs) or, (ii) the total fees paid by the BDC.”

Do Not Forgo Change of Control or Agree to a ROFO or FOFR

Your adVenture’s future is less certain than the future of the typical BDC, especially with respect to the timing and nature of your adVenture’s eventual exit. As such, craft your agreements to ensure your adVenture has maximum flexibility with regard to the scope and nature of future partnership and acquisition activities.

One tactic is to include a Change of Control provision in all of your agreements. Although the text can vary, the spirit of such provisions is the same: either party can terminate the agreement without recourse (i.e., without being liable for damages or other ongoing costs) in the event that a majority of their assets are purchased, transferred or otherwise merged with a third party. Happily grant this provision on a bilateral basis, as the risk of the BDC being acquired is usually relatively low and seldom would such an acquisition result in an adverse impact to a startup.

Neither party should be forced to terminate the agreement upon a change of control. Change of Control provisions will enhance your company’s attractiveness to a potential suitor. Thus, this provision gives you, and the BDC which may eventually acquire you, the option to maintain those agreements which remain advantageous to you post-exit and terminate those which might be problematic (e.g., a relationship with one of the BDC’s competitors, markets the BDC does not want to pursue, etc.).

Another way to maintain flexibility with respect to your exit is to reject Right of First Refusal (ROFR) and Right of First Offer (ROFO) provisions. Such provisions require you to notify the BDC whenever you are approached by a potential acquirer. BDCs cherish such provisions because they enable the BDC to dramatically influence the nature, scope and timing of your exit. As discussed more fully in Corporate Venturing, such terms are most commonly tied to corporate investments, as opposed to those made by institutional investors. Rather than trying to water down a ROFR and ROFO, your response should be, “No thank you,” whenever these terms are proposed.
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Part I of this series discusses the following contract traps:

  • Drafting the Agreement
  • Free Pilots
  • Multi-year Agreements
  • Termination Without Cause

Part III addresses these contract traps:

  • World-wide Distribution
  • Joint Intellectual Property Rights
  • Statements of Work
  • Product Bundling
  • Most Favored Nations Status
  • Exclusivity

Part IV addresses these contract traps:

  • Issue Unmitigated Exclusivity

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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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