2. Disclaimer
2
Tell me you did not see this coming …
Disclaimer
This presentation and these materials are for informational
purposes only and not for the purpose of providing legal
advice. You should contact your attorney to obtain advice with
respect to any particular issue or problem. The opinions
expressed in this presentation are those of the author alone
and may not reflect the opinions of the firm or any other
attorney.
3. Why Do Contract Terms Matter to Startups?
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Impact your business
Cash Flow
Pricing
Costs
Revenue Recognition
Impact the Value of Your Company
Diligence by potential investors and acquirers is very likely to
include a review of the terms of all material contracts
Restrictive and unfavorable terms may be used by an investor
or acquirer to negotiate down a proposed valuation/purchase
price
4. Note
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This presentation is written from the perspective of
the Startup as a Supplier. If the Startup is the
customer in the relevant agreement, many of the
issues discussed “cut both ways” but not all.
5. Payment Terms/Earliest Invoicing Date
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Agreements Need to Specify Payment Dates
Typically this is phrased as Net X, which means
payment no later than X days after invoicing
Supplier will generally want Net30. Larger
Customers have pushed for Net60 and even
Net90
Agreement needs to be clear when is the
earliest date that Supplier can invoice
Customer
6. Multiple Orders Under a Single Contract
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Agreements often provide that multiple orders can be
placed by the submission of Purchase Orders by
Customer
Important to make it clear that any supplemental terms
on the Customer’s Purchase Order will not apply
Supplier should reserve the right to reject Purchase
Orders. Potential reasons for rejecting invoices:
Customer is in breach of the Agreement with respect to prior orders
Customer’s credit profile has changed and Supplier may want to
consider requiring cash pre-payment or be unwilling to sell at all
Customer may not have sufficient inventory to fulfill the order within
the requested timetable
7. Calculating Royalties
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When the purchase price is a royalty rather than a fixed
price, it is important to specify the basis for the royalty
calculation
Often this is phrased as a percentage of Customer’s revenue
The Agreement should specify what is excluded from
“revenue.” Examples: taxes, insurance, shipping charges, and
returns
The Agreement should specify whether the royalty is based on
amounts payable to Customer or amounts received by
Customer.
Difference in who bears the risk of non-payment. Amounts payable =
Customer has to pay royalty even if its customer never pays. Amounts
received = Customer only has to make payment if it has received
payment from its customer
8. Defining Specifications in a Performance
Warranty
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Products are commonly warranted to function “in
accordance with their specifications”
It is often very unclear where you can find these
“specifications”
Product documentation and sales materials are usually
poor sources of specifications because they often include
a great deal of additional information and more salesoriented content
Ideally specifications should be in a clearly identified
document stating precisely what a product will do and
any minimum configuration required to support the
proper functioning of the product
9. Disclaiming and Conditioning Warranties
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Supplier should attempt to disclaim any warranties it is
providing in situations where the issue results from
actions of the Customer or Third Parties. Examples:
Modifications of the product by the Customer
Damage to a product by the Customer or usage outside of its proper
operating environment
Uses by the Customer of the product or service outside of its
intended purpose
In the context of online services, issues arising from delays or drops
in Internet connectivity
The Agreement should also disclaim certain warranties
implied by law. If you fail to do so, the Courts will add
these warranties to anything you agreed to.
Example: “The warranty of merchantability and fitness for a
particular purpose.”
10. Acceptance Testing
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Customers may ask for the right to perform
“acceptance testing” on products delivered to them
More common in situations of customer product
development instead of off-the-shelf
Supplier cannot recognize the sale revenue until the
end of the acceptance test period
Important to:
Limit the duration of acceptance testing; and
Make it clear that if a product is not rejected by the end of the
applicable acceptance testing period, it is deemed accepted
11. Most Favored Nationals Clause (“MFN”)
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An MFN Clause is an attempt by Customer to make
sure that it will always get Suppliers lowest price
Typical MFN Clause states that Customer’s price will
be lowered if Supplier offers a lower price to another
customer
Impact can be mitigated if the clause is limited to:
Other customers purchasing similar volumes, under similar
terms
Specific markets
12. Source Code Escrows
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When licensing software from Startups, Customers may
require that the Supplier deposit a copy of its source code in
escrow
The most critical element of an escrow agreement is the
conditions under which Customer can request a copy of the
escrowed code. Release from escrow should not be a remedy
for an ordinary breach by Supplier. It should be limited to
situations where the Supplier fails to respond for a prolonged
period of time/ceases to operate/enters bankruptcy
The escrow agreement should limit what the Customer can do
with the code if it is released from escrow (example: use
limited to servicing existing customers) and provide that the
code remains subject to all relevant confidentiality
obligations.
13. Exclusivity
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Customers may try to lock up a Supplier by requiring
exclusivity and preclude Supplier from selling to
other customers
This should be avoided because it limits the markets
open to Supplier
If exclusivity is required, it should be narrowed as to:
Duration
Geography
Market
14. Caps on Liability
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Cap on the maximum a Customer can claim from Supplier
under the Agreement
Generally Suppliers should be able to get a complete exclusion
of consequential/indict damages
Example: Software fails, brings down Customer’s production line
All other liabilities can generally be limited to a dollar
amount, usually pegged to sales over a give period
Example: Liability limited to all amounts paid by Customer to Supplier
during the 12 months before the claim
Customers may insist on exceptions to the cap.
exceptions:
Gross negligence
Breach of Confidentiality
Intellectual Property Infringement
Common
15. Liquidated Damages/Penalties/Service Credits
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Customers may ask for “liquidated damages”
(specified dollar payments), penalties or service
credits, instead of or in addition to the damages they
suffer as a result of breach
Most often raised in the context of late delivery,
delayed warranty/maintenance, or service downtime
If they cannot be avoided, important to cap the
maximum amount that can be claimed per
incident/per year. Also, preferred to offer credits
against future amounts due rather than cash
payments
16. Data Privacy/Protected Health Information
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Various State, Federal and International laws and regulations
govern a party’s handling of personal information with respect
to healthcare specifically (HIPAA) and data privacy generally
These requirements typically include
Heightened confidentiality obligations
Requirements for documented procedures for safeguarding the relevant
data and securing and limiting access to the devices where the data will
be stored.
Given potentially significant penalties for non-compliance, it
is important to understand what compliance requires
Increasing trend by healthcare, insurance and financial
services customers to impose data privacy language on all
Suppliers, even those that will not have access to personal
information
17. Shipping Terms
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When shipping product, the parties need to determine
Where/when the sale takes place (where Supplier makes it available for
Customer’s carrier or where Supplier’s carrier delivers it to Customer)
Who handles export/import matters and customs clearance
Who handles insurance
Who is responsible for import taxes
There are actually 2 questions
Who handles
Who pays
There are standard terms (under the Uniform Commercial
Code (UCC) and Incoterms) used as “short hand” to describe
the allocation of these responsibilities
Examples: FOB, Ex Works
See http://en.wikipedia.org/wiki/Incoterms for an
informative summary
18. Assignability
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Customers will often try to limit the Supplier’s right to assign
the Agreement without Customer consent
This clause can become a major issue when a company is
being acquired
This clause gives the Supplier comfort that it can prevent
transfer of the Agreement to an unreliable new Supplier.
However, it can also be used by the Supplier as leverage to
renegotiate the Agreement in return for consent to the
assignment
If the clause cannot be eliminated, the Agreement should
always specify that Customer’s consent may not be
unreasonably withheld
Supplier should try to get an exception for an assignment
made in connection with the sale of the company
