Tag Archives: Agreement

How Do You Structure an Earnout? Five Perspectives

Situation: A founding CEO is evaluating a purchase offer for his company. The buyer wants the CEO to retain some ownership interest to assure a smooth transition post sale, and ongoing assistance from the CEO so that the company continues to succeed post-sale. Should the CEO retain a minority share of the company? How do you structure an earn-out?

Advice from the CEOs:

  • The ideal option is full payment up-front. However, if the CEO is perceived by the buyer as critical to the company the buyer will want to have some assurance of continued services for some period.
  • An earn-out of fixed payments over time is acceptable provided that the language of the agreement is acceptable. However, performance-based earn-outs make no sense if the CEO no longer has control over the decisions that will impact performance. Don’t structure the payment as an earn-out, but as a retention bonus and assure that the terms are favorable.
  • Post-sale a minority share of your old company holds no value if you can’t monetize it. Holding a small share of a non-traded company has the same challenges.
    • It is all about liquidity.
    • If the other party offers this, ask what is the value is to you of the retained share.
  • Minimize the earn-out if one is demanded, but don’t count on it.
  • If there isn’t a strategic fit between the buyer and the company, the value of the company in a sale will be lower.

How Do You Optimize Supply Agreements? Seven Guidelines

Situation: A company wants to add off-shore manufactures to its supply chain. This is a new experience and the CEO seeks guidance on how to negotiate supply agreements. They want win-win agreements with their new suppliers. How do you optimize supply agreements?

Advice from the CEOs:

  • No supplier relationship is risk-free, especially if you are a small company. Be sure to cover ownership of new IP developed during the relationship. For example, assure that the supplier adds no new developments without communicating these to you in writing. You may want to fund new developments selectively to assure protection of your IP. This is essential if you need to switch or add suppliers rapidly to maintain adequate supply.
  • A service agreement is not always about cost. It’s about deliverables, and quid pro quo is important.
  • Manage your key supplier relationships as diligently as you manage your key client relationships. They are equally critical.
  • In a contract negotiation between supplier and OEM or customer, both sides need to clarify customer needs and supplier capabilities. The greater the transparency on expectations, deliverables, and contingencies, the better the agreement and contract.
  • In negotiating an agreement with a Chinese company, make the enforcement jurisdiction either Hong Kong or Macao. Why? So that courts can enforce terms of the agreement on the Chinese party in the case of a dispute.
  • Post-termination obligations are a key to any negotiation – you want this clarified in advance.
  • Contracts serve two purposes: a legal tool, and a way to drive behavior. They provide an opportunity to assure that both parties are on the same page and, under the best circumstances, serve as process documents.

Special thanks to Bijan Dastmalchi of Symphony Consulting for his contribution to this discussion.

How Do You Test for New Product Appeal? Three Suggestions

Situation:  A company was challenged by a client to design a product to demonstrate the capabilities of the client’s processor.  The result was a wonderful success, and has received very positive press. The client does not care about the product, only about their processor. How does the company test the appeal and potential marketability of the new product?

Advice from the CEOs:

  • Go to a local arcade, for example one operated by Golfland USA or a multiplex theater. Show them your product and ask whether you can test it for appeal with their customers. This will enable you to measure coin-drop numbers and generate demand and market appeal data. With these data you can assess the value of either selling or licensing the product.  The objective is to see whether the product generates sustainable demand, or whether it is just a short-lived curiosity.
    • The big issue with a product like this is very simple – is it addictive?
  • If your initial tests show that the product generates sustained interest and revenue it is similar to a console game. There are a number of avenues to pursue, including:
    • Early exclusives use agreements with casino or theater chains – it will have value if it helps them to drive traffic to their venues.
    • Novelty markets – corporate events, etc.
  • Other options:
    • Evaluate a lease model for target venues.
    • Consider selling the product to air table companies as a demo unit.

Arbitration or Suit to Settle a Dispute? Five Factors

Situation: A company has a long-term client that stopped a project suddenly 6 weeks ago with no explanation. Later, the client called saying that they do not intend to pay for work completed to date. Would you pursue either arbitration or injunctive relief to settle this dispute?

Advice from the CEOs:

  • If you have evidence of acceptance of a project contract or other documentation that the work proceeded under agreement with the client, this strengthens your position.
  • There may be other circumstances of which you are unaware such as financial or cash flow difficulties. Inquire through discrete channels to clarify this. Knowledge of the inside situation provides leverage as you negotiate a settlement.
  • Do you want to retain this client? If they have been valuable over the years this may just be the behavior of a single individual. If this is the case, work with your key contacts to bring this situation to light and try to solve the problem without legal action.
  • Because you have a long-term relationship with the client, focus your communications on the President rather than the VP who shut down the project.
    • Established your documentation, and complete your research on whether the client has cash flow problems; then call the President to work out an amiable resolution.
    • While you are justified in feeling miffed about the situation, business is business, and in this case it appears that your long-term relationship and the value of the ongoing business with the client outweigh the emotion of the present situation.
  • Focus on resolution of the dispute between the parties and do everything possible to resolve it between the companies rather than through legal avenues. This will help preserve the relationship with the client. Provided that you continue with this client, clean up the portion of the contract specifying notification and acceptance requirements and other areas of the contract that require attention.

How Do You Introduce New Information into a Negotiation? Five Thoughts

Situation: A company is negotiating an agreement to resell another company’s software. In due diligence the company encountered a customer who was offered a single user license for the same software at one-third the price that they have been asked to pay upfront. What is the best way to approach the vendor for additional information without divulging the source of his intelligence? Does this change the negotiation?

Advice from the CEOs:

  • There is no need to divulge your information source. Just say that you have done some research and quote the price that you found. Ask them to explain this to you. See how they respond. This may tell you a lot about how they operate.
  • What rights do you receive under the arrangement that has been offered by the firm? What exclusivity and guarantees will they offer? Will they write these into the agreement? How will they handle direct inquiries?
  • Perform a careful financial analysis of the opportunity. Model the market and the full cost of sales that you will encounter. What is customer purchase behavior? Is it changing?
  • Counter the vendor’s offer to you with a pay-down option that pays the vendor more over time, but allows you access to the software without a substantial up-front payment. This limits your exposure if sales do not ramp as you anticipate.
  • Visit the vendor and sit down with the President. See how this individual responds to your questions. You may get a much better deal through this approach than through the sales team. You also may develop other partnership options that can benefit you long-term.

Key Words: Reseller, Agreement, Price, Software, Due Diligence, Negotiation, Research, Exclusivity, Guarantees, Direct Inquiry, Analysis, Customer, Behavior, Counter, Visit

Partnership Agreement for a New Venture: Seven Points to the Negotiation

Situation: We are negotiating a partnership venture. We would fund the entity, and the partner will earn ownership through sweat equity. How do we draft a fair partnership agreement?

Advice from the CEOs:

  • The most important factor is the ability of the two partners to drive a successful venture: proof of ability to contribute needs to be a prerequisite to allocating ownership.
  • How does the sweat equity partner prove their capability?
    • Create a schedule of milestones for the partner to earn ownership, based on mutually agreed objectives or revenue generation.
      • The beauty here is that you retain control until the partner has proven their value by delivering results.
      • The potential downside is long-term liability of the venture.
        • The longer that you retain majority ownership, the longer you retain majority liability.
        • Insure yourself against this liability.
    • Buyout clauses are important to retain your interest if the partner fails to deliver.
    • Include a liquidation clause in case the venture fails.
  • Negotiating the agreement:
    • Draw up a 6-month letter of intent. Specify what each side brings to the table and what each commits to deliver. Set clear, measurable, time-bound objectives.
    • Negotiate fair protections desired by each party.
    • Consider a consultant to facilitate settlement of areas of contention.
    • Theoretically, each party needs their own legal counsel. This adds expense but provides protections for each in the final agreement.
    • Factor the cost of legal advice as well as consultant facilitation into your planning model.

Key Words: Partnership, Joint-Venture, Sweat Equity, Agreement, Negotiation, Buy-Out Clause, Liquidation Clause, Letter of Intent (LOI)