Kiss of Death - Contract Provisions Entrepreneurs Should Avoid at All Costs
Agreements with Big Dumb Companies
(BDCs) are like DC Comic’s evil villainess, Poison Ivy. Both are seductive
and alluring and both are potentially fatal.
As a startup, your most meaningful
agreements will likely be struck with BDCs. You will no doubt craft
agreements with companies of similar or even smaller size compared to
your own, but the risk associated with such agreements will be tempered
by the fact that you will negotiate such agreements as a relative peer.
As such, your greatest risk and greatest opportunity will arise from
the deals you cut with larger entities.
Fortunately, it is possible
to craft lucrative deals with BDCs that do not limit your venture’s
ability to charter its own destiny. Just as Batman must avoid Poison
Ivy’s kiss of death, so too must entrepreneurs avoid the Kiss of Death
provisions which BDCs often attempt to include in their agreements.
Kiss of Death Provisions
The allure to of a company-changing
deal with a BDC is strong. Big companies make a number of seductive
promises, including access to large markets, significant financial resources
and vital public validation of your solution. However,
fight the urge to close such enticing deals on the BDC’s terms. Stand
your ground and negotiate a fair agreement, even if it takes longer
and forces you to expend more energy than you would prefer.
To this end, never agree to
any of the following Kiss of Death Provisions when negotiating with
a BDC, no matter how lucrative the potential relationship:
- Allow the Other Side to Draft the Agreement
- Deploy a Free Pilot
- Cut a Multi-year Agreement
- Lock Down the Escape Hatches
- Give up Branding
- Relinquish Press Release Capabilities
- Approve Unilateral Provisions
- Accept Unlimited Liability
- Forgo Change of Control or Agree to a ROFO or ROFR
- 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
Do Not Allow the Other Side
to Draft the Agreement
Insist on creating the initial
draft of the Agreement in order to gain the following important advantages:
- Control the tempo of the discussions – if you rely on the other side’s lawyers to create the agreement, the deal may lose momentum as it sits in the lawyer’s In-box
- Establish fair, bilateral covenants – agreements from large companies generally come with numerous unilateral covenants that can cost you valuable negotiation currency to unwind
- Ensure the spirit and integrity of the business terms are not hijacked. A BDC lawyer who is not closely involved in the negotiations may, inadvertently or otherwise, craft an agreement that modifies some of the negotiated deal points.
- Shade minor aspects of the deal in your favor, such as: payment terms (i.e., 30-days vs. 45-days), percentage of irregularities which dictate who pays for an audit (i.e., 3% vs. 7%) the manner and venue in which disputes will be resolved (i.e., arbitration vs. litigation), etc.
As you draft the agreement,
include specific examples, especially when numeric formulas and calculations
are involved. For instance, if you are describing the terms of a licensing
fee, add one or more real-world examples which utilize real numbers.
This ensures that everyone understands the key formulas, and thereby
avoids a common point of contention in deals that go awry.
Do Not Deploy a Free Pilot
If you allow your prospective
partner or customer to milk the cow for free, why would they
ever pay for it? Your most valuable asset is time. You cannot afford the
opportunity cost of a deal that does not generate revenue. Thus, if
your venture must expend resources in conjunction with a Pilot, insist
on being compensated for the use of such resources.
- If your Bro Foe does not have skin in the game, it is highly likely that your Pilot will become derailed and overtaken by other priorities. The best way to ensure that your potential partner has sufficient incentive to guarantee the Pilot’s success is to require them to invest cash upfront. Ideally, this cash should find its way into your pocket in the form of a Pilot Implementation Fee.
- Forcing the other side to pay a meaningful upfront fee requires them to determine the merit of a potential relationship with your firm at the outset – before you invest either your time or money. If you enter into a development or trial partnership for free, you are allowing the BDC to forestall its ultimate determination of the value of the partnership.
- If necessary, apply a portion of the Pilot Fee toward the ultimate license / purchase price. Clearly communicate that you are not attempting to get rich on the Pilot Fee. On the contrary, you are simply assigning a cost to your time in order to mitigate your downside risk and to ensure that both parties properly evaluate the economic viability of the deal upfront.
- Insisting to be compensated for your time will also help elicit the necessary respect from the BDC. Convey that your company is in demand and that you do not have to give away your time or technology in order to entice BCDs to partner with you.
Oh, but you scoff. I have negotiated
deals with numerous high-profile BDCs that included significant Pilot
fees. In one instance, we were paid $50,000 and the Pilot was never
implemented due to the fact that the BDC was acquired after the Pilot
Agreement was finalized.
Do Not Cut a Multi-year
In the life of your venture,
a year is an eternity. You cannot afford to limit your future prospects
by entering into a multi-year deal. BDCs generally prefer multi-year
agreements because long-term deals reduce the BDC’s uncertainty and
thus lower its risk. Conversely, long-term deals reduce your flexibility
and potentially increase your opportunity costs.
Some BDCs may attempt to force
you to agree to an evergreen termination provision. Such covenants require
written notice of termination within a specified period of time prior
to the end of the term in order for a party to terminate the agreement.
If such written notice is not made, the agreement is automatically extended,
usually for an additional year.
Never agree to such a provision.
BDCs can afford to hire large staffs to adequately track all of the
evergreen provisions in their contracts. You will not have that luxury.
The chances of your company missing a termination deadline are high,
which could result in your venture being locked into a disadvantageous
deal for an additional year.
Rather than agreeing to an
evergreen provision, suggest that both parties mutually agree upon additional
one-year increments in writing, at the end of each term. If the other
party insists on an evergreen term, negotiate a reasonably conscribed
no cause termination clause. This will significantly reduce the
risk associated with inadvertently rolling into an additional year,
as you can simply exercise the “out” clause and terminate the agreement.
Do Not Lock Down the Escape
Agreements are obviously intended
to bind both parties. However, avoid writing contracts that may contractually
hold the other party to an economically infeasible deal. If the relationship
is not advantageous for the other party, there are many legal
ways a BDC can undercut and effectively terminate the deal.
As noted in Roping
in the Legal Eagles,
successful entrepreneurs are generally not litigious. Even if you are
a mean cuss, your startup will likely not have the financial resources
to hold a BDC to disadvantageous deal terms. Thus, you gain nothing
by crafting an agreement that contractually forces the other party to
work with you, irrespective of he financial outcome of the relationship.
Ideally, either party should
be free to terminate the agreement, after a reasonable notice period.
By allowing either party to walk away, you force both parties to continually
strive to maintain a mutually beneficial relationship.
One exception to this easy-out
philosophy is with respect to recouping any substantial investments
you make on behalf of the partnership. Irrespective of the easy-out
clause, ensure that your costs are reimbursed in the event of early
termination by the BDC. Such reimbursement might be in the form of a
walk-away fee to be paid by the party who terminates the relationship.
If the walk-away fee is unreasonably large, it is possible that the
BDC will breach the agreement and refuse to pay the fee. As such, keep
any such fees reasonable.
Do Not Give up Branding
BDCs will often ask you to
“private label” or “white label” your technology. This
generally involves the BDC selling your technology in a form that allows
them to market it under their brand. Do not allow your venture’s
technology to be buried in the bowels of another company’s product,
without obtaining proper recognition. For instance, in its early days,
Google syndicated 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 most 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.
Your venture 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. Such validation 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. In many partnership
discussions, I was able to direct a potential partner to an existing
partner’s website and show them our “Powered By” branding status.
This approach was very effective. If I had been forced to say, “I
know you cannot see it, but our technology is the engine behind Company
XYZ’s product,” my ability to establish new partnerships would have
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
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
Do Not Relinquish Press
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 embarrassed, most BDC partners attempt to preclude you from
issuing any unilateral press releases. Some will even try to keep 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 is 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 also likely it will not receive wide media coverage,
even by the financial and industry analysts who follow the BDC, thereby
further reducing the BDC’s risk.
In some cases, the credibility
generated by your association with a BDC is the most valuable aspect
of the relationship. This is especially true in instances when the BDC
grinds you down on the financial terms. In such instances, the level
of public relations autonomy you negotiate can 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
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
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 business terms as possible, as it reduces
potential confusion and establishes a collaborative tone to the relationship.
As noted previously, 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 on just to get you back 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. What is goose
is good for the gander. If you accept unilateral terms, you risk
becoming a Corporate Beyotch.
Do Not Accept Unlimited
Another common unilateral provision
is one in which a BDC proposes to limit the scope of its damages with
a de facto 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,
you can craft a deal that allows both parties to attain their respective
goals. You can do this in the Indemnification Section of the agreement
by placing a de facto cap on the amount of expenses 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 venture’s future is
less certain that the future of the typical BDC, especially with respect
to the timing and nature of your venture’s eventual exit. As such,
craft your agreements to ensure your venture has maximum flexibility
with regard to the scope and nature of future partnership and acquisition
One tactic is to include a
Change of Control provision into all 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. 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.
Do Not Serve up World-wide
Value-Added Resellers (VARs)
will often seek to obtain the largest geographic territories possible.
However, only grant distribution in areas in which the VARs have a proven
footprint. As they expand their business, you can expand the scope of
In the early stages of your
venture, it may be difficult to obtain tier-one distribution partners.
Thus, you may initially be forced to establish relationships with smaller
VARs with limited, regional coverage. This will prove problematic as
your business grows, because it will be difficult later to sign up larger
VARs, unless you are able to offer them uncontested, broad geographic
coverage. As such, always reserve the right to terminate regional distribution
agreements in the event that you subsequently enter into a pan-country
Do Not Relinquish
Joint Intellectual Property Rights
Intellectual Property (IP)
provisions should ensure that both parties maintain the IP rights that
they respectively own at the outset of the relationship. This is generally
a straightforward and uncontested provision.
A more complicated negotiating
point involves IP that is created in the course of the parties working
together. Any such “joint IP” should be equally and severely co-owned
and each party should retain the rights to utilize the joint IP in any
fashion they deem appropriate. The BDC will generally agree to such
a provision, even though there is typically little they can do with
such incremental inventions in isolation, as they will likely be based
upon your underlying IP.
Guard against being precluded
from marketing and otherwise utilizing novel, joint IP developed during
the course of carrying out the agreement. Craft terms which ensure you
will not be obligated to the BDC with respect to the terms by which
it can profit from jointly developed technology.
Once your development team
begins working with the BDC, do not allow the BDC to unilaterally create
any meaningful IP without your team’s involvement. If the BDC iterates
on your technology and devises novel IP without your involvement, you
risk your IP becoming subsumed by the BDC’s technological advances.
Such unilateral development should be explicitly precluded in the agreement
if you anticipate that this is a material risk.
Do Not Execute an Ambiguous
Statement of Work
The Statement of Work defines
the specific actions and responsibilities to be carried out by each
party in the fulfillment of their responsibilities covered by the agreement.
It should be codified as part of the definitive agreement in the form
of an Exhibit.
In most cases, your
tech team (not the BDC’s) will do most of the heavy lifting and will
bring the majority of the technological value to the relationship. In
order to optimally manage your limited resources, it is in your best
interest to clearly specify the work to be performed, who will perform
it and when each significant task is scheduled to be completed.
The Statement of Work should
include a Non-Recurring Engineering (NRE) budget that estimates the
resources required to complete each major milestone. If the NRE budget
is exceeded and the reason for such overages are due to the actions
or inactions of the BDC, the agreement should stipulate the scope of
To ensure that the BDC judiciously
uses your resources, assign a relatively high cost to your engineering
personnel’s time. By establishing an NRE budget upfront, the BDC will
know how many “free” NRE hours are included per the agreement and
what it will cost them when they invariably ask you to expand the scope
of the project.
You will generally be pleased
to expand the scope of BDC partnerships. However, contractually ensure
that any such expansions are at your sole discretion. If you allow the
BDC to unilaterally expand the scope of your involvement, you have effectively
abdicated control over your technological resources. A detailed NRE
budget will help you avoid becoming the BDC’s adjunct engineering
If you do not assign a price
tag to your engineering team’s time, an aggressive BDC could quickly
consume all of your technical resources, precluding you from executing
other technical initiatives. You cannot afford to consolidate your development
efforts on a single relationship, no matter how lucrative it may appear
at the outset. The risk and associated opportunity cost of a single
relationship failing is too high and could potentially lead to the demise
of your venture.
Do Not Agree to Bundling
Without a Minimum Price
Bundling deals can be attractive,
as your product and/or technology can potentially reach a large audience
by piggybacking on the reputation and market share of the BDC’s established
brand. To ensure that such bundling is financially worthwhile, negotiate
a de facto minimum per unit price.
A BDC will often encourage
you to accept a percentage of the price they charge the end-user for
your technology. If you do not negotiate a minimum price, the BDC may
prove that they are not so dumb after all and give your product away
as a loss-leader to induce sales of their product(s). Without
a minimum price, you could be paid a percentage of nothing, or next
to nothing, depending on the price the BDC charges its end-users. Since
you cannot control your partner’s end-user pricing, you must specify
the minimum amount that you will be paid (per unit, per month, whatever
is most appropriate to the relationship).
Do Not Grant Most Favored
Many BDCs relish this onerous
provision. A Most-Favored Nations (MFN) clause essentially states that,
“Mr. Little Company can never do a similar deal with anyone, under
any circumstances that is better than the deal cut with the BDC.”
Clearly, this is the sort of provision that a savvy entrepreneur will
never fall prey.
The path of your venture
is far too unpredictable to anticipate the nature and scope of every
future opportunity. As such, your goal when negotiating a MFN clause
is to maximize your flexibility and keep as many future options open
The MFN provision is a slippery
slope and often a tripwire to a lawsuit. Do everything you can to avoid
granting it. I have crafted hundreds of agreements and I have only agreed
to this provision, in a highly-watered down form, in a handful of instances.
Although it may require tenacity, you can generally negotiate this provision
away, even if the BDC tells you, “We always get this provision.”
My response to such BDC nonsense is, “Great. This sounds like an interesting
challenge for us to devise a reasonable alternative because I love being
One way to denude this provision
is to wrap caveats around the term “similar” and to liberally use
the word “substantially.” For instance, you might propose something
to the effect of, “Startup X agrees to not enter into an agreement
with substantially lower pricing based upon substantially similar volume
Do Not Issue
Unmitigated exclusivity can
be the death knell of a small company. It is often alluring, as it is
generally granted in exchange for upfront cash and/or the promise of
a significant, future relationship. However, if given the chance, the
BDC may put your technology on the shelf, either as a competitive reaction
to remove your technology from the market or, more commonly, because
they become distracted and lose focus once they realize your technology
cannot be deployed by their competitors.
Batman thwarted Poison Ivy’s deadly kiss by coating his lips with an antidote before taking her up on her seductive offer of romance. By effectively structuring your agreements, you too can enjoy a relationship with a BDC without suffering the potential deadly consequences.
"Uncle Saul" is a serial entrepreneur (who wishes to remain anonymous) who has led one IPO, was window-dressing in another and has executed several M&A transactions, all of which collectively generated over $450 million in shareholder value. Saul is a CPA and a Wharton MBA who never qualified for the PGA but likes to watch the NBA. Uncle Saul is also a songwriter who managed a successful rock band and plays an awesome iPod. He also teaches would-be entrepreneurs at a major California university. You can read more of his thoughts at www.infochachkie.com. .