On June 22, 2012, I gave a presentation on commercial contracting for early stage companies to The Next 36, an innovative mentorship program for young business leaders. The Next 36 allows talented undergraduates to form innovative businesses with the help of mentors, sponsors and instruction. Presenting to the students gave me an opportunity to share some key pointers relevant to commercial contracting by early stage companies. Our work with management teams running high growth, early stage businesses necessarily involves some trouble-shooting; we (and our clients) learn from assignments where we’re renegotiating and adjusting commercial arrangements to get right, at a later stage, what would in a more ideal world have been addressed up front.
It can be difficult for early stage companies to muster the resources to properly review and negotiate commercial agreements. Available time and resources are understandably consumed in formulating business plans, obtaining money and the other 24/7 demands of a start up. The ramifications of getting things wrong, however, can be disastrous for the business. Ending up with ownership issues in a consulting contract or getting the scope of a critical licence agreement wrong may not just impact a small portion of a business, as is the case for large enterprises, it may undermine the entire business. At this stage, companies often have to accept standard form or adhesion contracts with little opportunity to negotiate changes – in most cases there just isn’t enough money in it for suppliers to offer significant concessions.
While not an exhaustive list, here are a few significant issues:
NDAs should be the rule any time sensitive business ideas are discussed with third parties. Sometimes it’s not possible in early stages to enforce this discipline, but where there is no NDA it should affect behaviour. For example, especially sensitive information (such as source code) should never be shared except pursuant to an NDA.
Read other parties’ forms of agreement carefully; look out for non-standard ownership language, non-competes or grants of rights to use your information.
The behaviour relating to receipt of confidential information is as important as the agreement. Ensure that use, storage, destruction and who gets access to confidential information is documented. If a third party claimed that you incorporated and misused their confidential information in your product, would you be able to conclusively demonstrate that you didn’t?
You have to get the ownership right in consulting agreements. It is vitally important that the central assets of the company can be demonstrated as being fully owned. This means proper assignments for all components that you intend to own, and disclaimers of moral rights. Beware of simple declarations of ownership and “work for hire” language – this is a US and not a Canadian legal concept.
The scope of services expressed in a contract- clear expressions of what is being paid for and how much – is also important. Runaway projects are common. Costs mount and deliverables are late or don’t materialize. Many times this is because the parties did not express clearly – at the outset – what each expected of the other.
A clear right of termination (for any reason) by the customer is desirable. At this stage in your business’ life, your ability to seek remedies through courts or arbitration is limited; being able to walk away from a bad arrangement is essential.
Most businesses will in-license critical software as the most economical way to achieve their goals. Getting the license scope right is important. Licence scope limitations can include:
- use in a limited territory;
- use only for a purpose, either general (e.g. “internal business purposes”) or specific (use in a specific business);
- use on specific machines or locations; or
- limited to certain users.
Licenses also typically include specific exclusions, such as the common prohibition on use as a “service bureau” to process other parties’ data . Consider the scope and restrictions carefully. Do they fit the scope of the business as it is being launched and as it will look if your business plans are realized? It is common to discover inadequate licensing at the heart of a business, and it can cost to fix it.
Also consider how the software is supported and the cost. Total cost of the software including the support must be factored into business plans.
Open Source Software Cloud Computing
“Open source” is a label applied to a wide variety of software products which are generally available without charge. Open source has obvious attractions for early stage companies. But you need to remember that open source software is subject to binding licence terms and, just as with proprietary software, it is important to fully appreciate the implications of the licenses. This is particularly true with respect to licenses that require any source code intermingled with the open source software to be licensed under the same open licensing model (the most famous example being the GPL).
Cloud computing has put economical computing horsepower into the hands of early stage companies earlier than would formerly have been possible. It makes possible businesses that could not have gotten off the ground 10 years ago. There are a number of pitfalls, however. Performance guarantees and service levels may be limited. Where a business supported by cloud services is being sold on to downstream customers (such as a mobile app or service), it’s important not to commit to service levels not supported upstream. You need to understand how data (i.e. personal information) will be treated and, if important intellectual property will reside on the service, whether and how it and personal information can be retrieved down the road.