4 minute read / Nov 14, 2012 / best practices /
Partnerships for startups - Key deal terms
Yesterday’s post on distribution partnerships for startups elicited a few comments and questions about other important elements startups should consider when contemplating partnerships. I’ve listed a few other major partnership elements below.
Qualifying the Partnership
Quality of inbound traffic - As part of measuring the cost/benefit of a partnership, it’s critical to understand quality of traffic/customers from a distribution partnership, as @jamesreinhart pointed out. Ideally, a startup should collect data on the performance of a distribution channel before entering into a long-term agreement with a partner. Conversion rates can vary widely by channel and lots of poor traffic isn’t worth the effort.
Setting the Partnership on a Path to Succeed
Internal dynamics play a huge role in the success of a partnership. With large scale or long term partnerships, an internal champion whose job is on the line is essential for the success of the partnership.
Additionally, it’s critical to understand your potential partner’s motivations for working together and structuring the deal so that both parties are motivated to cooperate - and that incentives don’t diverge with time. Is this a check-the-box partnership or is this a strategic priority for your partner?
Spifs or sales incentives If you are considering a distribution or sales channel partnership, spiffs or sales promotion incentive funds ensure that sales teams working for your partner are paid to sell your product. Without spifs, salespeople aren’t going to push your products because they make no extra money. Ideally, your partner bankrolls the spifs. Or the costs are deducted from their portion of the revenue share.
Marketing commitment is a critical focal point for distribution partnerships. Successful partnerships often have marketing performance metrics in the contract. This can be as high level as a dedicated marketing budget or as low level as guarantees on the number of customers/leads. Without any of these terms, the partnership has the potential to flounder in obscurity.
Remuneration - If the partnership requires engineering or additional service level agreements, an up-front NRE (non-recurring engineering) fee from your partner is a common way to finance this work. Ideally, a startup uses this NRE to finance and accelerate development on the product roadmap. NRE payments have seduced startups in the past (including one I worked for). Pursuing NRE as cash-flow at the expense of its roadmap, transforms the startup into a consultancy - not the best outcome.
Other forms of remuneration include revenue share - the split between the parties. And of course revenue guarantees. Guarantees tend to misalign incentives for partners. Whoever is guaranteed revenue can just put their feet up while the partner works hard to make money. Avoid them.
Exclusivity is generally a very bad thing. Large companies try to enforce exclusivity to prevent their competition from working with a startup. Obviously, such an overbearing constraint limits the size of a startup’s market.
There are several effective strategies to negotiate against exclusivity: (1) offering exclusivity for a short period of a few months; (2) limiting the breadth of the exclusivity by explicit naming of competitors that startup cannot partner with; (3) framing the benefits of working with multiple partners as a benefit through shared data, shared product features or some other mutual benefit; (4) framing the startup’s success as critical to the health of the partnership.
Strategic investments - Sometimes partners like to invest into a startup as part of a partnership. They would like to participate in the upside of the success they engender. The cash infusion is alluring for the startup and typically strategic investments occur at better terms than those of the venture market.
Strategic investments may grant a partner information rights - detailed knowledge typically shared only with the board. Knowing much about a startup provides the partner an effective right-of-first-refusal to purchase the company.
Should an acquisition offer arrive from a third party, your partner will be made aware. This skews the dynamics of an M&A process to the detriment of the startup.
First, the partner will have had extensive access to the company and its assets, which means the partner can price the company better than any third party. A third party would have to be foolish to pay more than the partner. Second, the partner will be made aware of incoming M&A interest and has an effective right-of-first-refusal. They may increase any third party’s bid by 5% and win the deal. Messy dynamics indeed.
By and large, I encourage only later stage companies (post-Series B) to consider strategic investments. At later stages, the valuation a company can command limits the ownership a partner will purchase, limits information rights and rids an M&A process of the effective ROFR dynamic.
Breach - Both sides will want a clause that spells out the terms for breaking the partnership. The amount of notice, size of damages, process for restitution and so on should be explicit.
Lastly, it’s important to remember very partnership is different. Key points of negotiation vary widely. Having experienced counsel and a strong board is a big help in evaluating partnerships.