Don’t let ‘Exclusivities’ take your venture down! - SoumitraSharma,IDG Ventures India

Consider the following scenarios:Scenario 1: Tech Networks is a high potential software products company in the education space. It’s already starting to see traction pick up with Indian higher education institutions when lo and behold, it receives an inbound query from a potential channel partner in the Middle East. The Partner asks for exclusivity for Middle East and North Africa region – Tech Networks gets excited at the prospect of its first international foray, and signs the first draft itself of the legal agreement sent by the Partner. What the venture doesn’t realize is that the channel partner is only the 8^th largest distributor of education software products in the region, with strong presence in only 30% of the region, and no direct presence in North Africa.

Scenario 2: Ren Technologies is a high potential Indian startup in the solar energy space. It’s close to developing a revolutionary off-grid technology, but doesn’t have the infrastructure to develop a key part of the solution. It contacts a boutique R&D firm in Europe that specializes in this domain, and signs their “standard” engagement contract. This agreement states that rights to all Intellectual property (IP) developed by the European firm in this project would wrest with it, which would be over and above the hourly engineering charges Ren will have to pay for getting the scope of work executed.To enable commercialization, the European company would exclusively license out this IP to Ren. Excited about immediate business prospects of the solution, Ren accepts all terms and conditions without any questions.

Scenario 3: Mob Inc is a disruptive Indian venture in the mobile space, and has developed a first-of-its-kind Value Added Service (VAS) product. A large government owned telecom player loves the product but asks for exclusive rights to the platform. Since the telco is extremely large anyway, Mob doesn’t think twice before giving the exclusivity, only to realize a year later that the platform is no longer a part of the telco’sstrategy and is therefore, not getting pushed at all in the market by the telco.

Though these cases are hypothetical, they represent real life examples of ‘un-smart’ distributor, technology/ IP and customer exclusivities that Indian ventures tend to give to third parties.

Why ‘Exclusivities’ don’t make sense!

Why get tied at the hip with fortunes of some-one else? – The venture’s fortunes will fluctuate with that of the exclusive partner. As a startup, one can hardly control the strategic choices the partner makes, especially with the enormous amounts of information asymmetry that would usually be at play. One major downtick with the exclusive partner could potentially wipe out the venture.

The Venture should exclusively own all IP – in most high-tech sectors, IP is the core of the business. The venture’s core value flows from it, and even a small yet critical part of the IP wresting with a third party can seriously jeopardize the venture’s business freedom and future prospects.

VC’s hate it – institutional investors hate anything that compromises a) business upside of the venture b) raising follow-on rounds c) exit from the business. Exclusivity agreements compromise a majority of thesein most cases.

How to ensure Watertight Contracting?

Hire a good Law Firm – Bad contracting is a binary risk for the venture – an unfavorable contract could potentially wipe out the company. The first step towards creating water tight contracts is to hire the best Law Firm the Company can afford. In case of special contracting situations such as IP transfers, hire domain experts. It’s a completely necessary and worthwhile investment; one, if underestimated, could lead to major regrets down the road.

Always refer to industry standard contracts as references – with or without a Law Firm, it’s extremely important to dig out standard contracts through your networks and study them in order to understand which clauses are ‘standard and industry accepted’ and which aren’t.

Negotiate, negotiate, negotiate! – As a startup, expect to receive exclusivity proposals from even moderately large players, looking to extract their pound of flesh. Have confidence in your offering – if a strong enough business case exists, chances are they need you as much as you need them. So, negotiate! Try and figure out what a mutually acceptable option(s) would be, and work towards it. Also, itwould be immensely useful to brush up on classic negotiation concepts such as BATNA (Best Alternative to a Negotiated Agreement), Reservation Prices and Anchors, and go into the meeting with well formulated negotiation strategies.

Contracts need to be ‘structured’ to arrive at a middle ground – Explore how various levers of the agreement can be structured to negotiate exclusivities out of the equation. Can a ‘flat payment + royalty’ structure be introduced to induce the other party to transfer all IP in the venture’s name? For an unavoidable exclusivity with a large customer, can levers such as exclusivity time period, a ‘floor’ for minimum annual business for the venture, suitable penalties for unmet commitments etc., be used to safeguard the venture’s interests? Can certain softer preferences such as a “Most Preferred Distributor” status be worked out, instead of granting full distribution exclusivity?

Be especially conscious of drastic words in the contract such as ‘perpetual’, ‘irrevocable’ etc. – caveats and structures are any day better than unequivocal rights, unless they are explicitly beneficial for the venture.

Do special diligence on overseas players – Expect information asymmetries to be even higher in case of overseas players, which would require more detailed diligence. What is the player’s market share in the category? Does it have a weak/ medium/ strong presence in geographies/ segments strategic to the venture? Does it have other similar relationships and how have they panned out? How is the player’s overall reputation in the market?

Choose a professional setting and demeanor for exclusivity negotiations – Having an exclusivity negotiation over a beer is a bad idea, even if there is past personal bonding with the other party representative.

Don’t rush into it – Ideally, have multiple rounds of negotiation and then, sleep over the final agreed draft. Also, it’s always a good idea to take a couple of unbiased business opinions on the agreement, especially from contacts who have held senior positions in the past and have seen such contracts pan out in reality.

Even with all the above guidelines and frameworks, the most critical step as an entrepreneur would still be to first start appreciating the importance of water-tight contracting. Once this happens, most other things would typically tend to fall in place. 

* Note – The views and opinions expressed in this articleshould not be construed as legal advice. 

If you would like to discuss your venture or business plan, or simply bounce off any ideas, Soumitra can be reached at [email protected]. You can also follow him on Twitter @soumitra_sharma.

Disclaimer

The views and opinions expressed in this column are strictly personal, and not those of any organization/institution the author is or has been a part of, nor is made in any official capacity of such organization/institution, unless explicitly stated otherwise. None of the information, views and opinions in the column should be construed as business or legal advice.