Contractual Traps Entrepreneurs Must Avoid
ConTraps Part III – Contract Traps Entrepreneurs Should Avoid At All Costs

		 Note: This is part III of a four part series. Access part I HERE, part II HERE and part IV HERE.
As noted in parts I and II of this series, agreements with    Big Dumb Companies (BDCs) can be alluring and potentially fatal. In many    cases, agreements contain the promise of future riches, much like a piece of    cheese in a mousetrap.  
This series describes how entrepreneurs can craft    company-changing agreements with BDCs, while avoiding Kiss of Death contract  provisions.
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Get The Cheese With  Your Neck Intact
In Part II of this series, I suggest that  entrepreneurs seek agreements in which “what is good for the goose is good for  the gander.” In other words, if the BDC insists on including a specific  provision in your agreement, it should apply equally to both parties. This egalitarian  mindset will result in agreements in which both parties benefit directly  from the results of their relationship, either in the form of revenue or cost  savings. In Sharing Means Caring, I describe specific tactics that foster  and extend the longevity of such mutually advantageous relationships. 
When creating such sharing relationships with a BDC, ensure  that you never agree to any of the  following Kiss of Death Provisions, no matter how lucrative the potential  relationship may seem at the outset.
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

Part IV

Issue Unmitigated       Exclusivity
  


Do Not Grant  World-wide Distribution
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 their territory.
In the early stages of your adVenture, 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. 
Although necessary, “stepping stone” approach of initially utilizing  smaller VARs to enter new geographic markets can become problematic as your  business grows, because large VARs often demand uncontested, broad,  multi-country coverage. Avoid this potential conflict by reserving the right to  terminate regional distribution agreements in the event that you subsequently  enter into a pan-country distribution agreement. In some instances, it will be  appropriate to grandfather ongoing payments due regional distributors for their  past performance. Rewarding the small VARs for working with you when the larger  distributers would not is the Bro thing to do. 
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’ collaboration. 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 a preclusion that would deny you from  utilizing the IP developed during the course of executing the agreement. Craft  terms which ensure you will not beholden to the BDC with respect to your  ability to subsequently deploy and 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, clearly specify the work to be performed, who  will perform it and when each significant task must 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 your compensation (e.g., $250 per hour, plus materials and  associated out-of-pocket expenses). 
As articulated in Corporate Venturing, a risk in jointly developing and/or  integrating technology with a BDC is that your company’s primary mission can be  inadvertently hijacked. 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, outsourced engineering team. 
If you do not assign a price tag to your engineers’ 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 adVenture. Underestimate this risk at your peril.
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 fail to 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 Nations Status
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 adVenture is far too unpredictable to  anticipate the nature and scope of every future opportunity, as made clear by  the examples cited in Optimistically Pessimistic. As  such, your goal when negotiating a MFN clause is to maximize your flexibility  and keep as many future options open as possible. 
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, I love doing things differently. This poses an interesting challenge,  but I am confident we can devise a reasonable alternative that addresses your  underlying concerns.” 
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 a like-sized partner, which grants substantially lower  pricing, given that such partner agrees to substantially similar volume  commitments.” 
Do Not Issue Unmitigated  Exclusivity
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. For this reason, exclusivity  at a startup is more aptly termed Excludesivity, as it guarantees your  adVenture will be excluded from leveraging future opportunities.
See Part  IV of this series - for an in-depth discussion regarding how you  can effectively negotiate this most heinous ConTraptual provision.
If you abide by the suggestions outlined in this ConTraptual  series, the resulting mutually advantageous agreements will ensure that you can  eat your fill of cheese without having to perpetually fear that an unforeseen trap  will suddenly break your company’s back.  

					



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