Enticing Contract Conditions for Key Accounts
September 30, 2015 6:44 PM Subscribe
As a small software startup, we are getting real interest from very interesting clients, but they are concerned about our long-term survival. How to neutralize these concerns?
I'm a partner in a tiny software startup (an advanced portfolio management system for investment companies) and we are getting interest from several medium-sized companies ready to buy our product.
These would be key accounts in the sense that they would increase our visibility by referral and of course increase revenue as well, which at this point in time is quite useful, although we already reached actual break-even. They all like the system very much, but the fact that we are newly established is a problem since if we disappear their investment is gone. Entirely gone in case of bankruptcy or our long-term servicing might degrade in case of a buy-out. Migration to a new system in this industry is a major deal, so they all know they better get the right one.
We are open to talk about "special conditions" in our contracts, but for now we haven't found anything acceptable for us. For example, one company asked for an equity stake, one for an equity swap, two others a seat on the board, another requested that we put our source code in escrow.
We fully understand their concern, but we can't give equity or board seats to clients mainly because their competitors (the rest of our market) would immediately lose interest in the system. Plus, it would be smart to retain as much equity as possible for potential major opportunities down the line, rather than "sacrificing" it for a single client.
What could we offer these key clients to neutralize their concern related to our long-term survival or ability to service them?
I'm a partner in a tiny software startup (an advanced portfolio management system for investment companies) and we are getting interest from several medium-sized companies ready to buy our product.
These would be key accounts in the sense that they would increase our visibility by referral and of course increase revenue as well, which at this point in time is quite useful, although we already reached actual break-even. They all like the system very much, but the fact that we are newly established is a problem since if we disappear their investment is gone. Entirely gone in case of bankruptcy or our long-term servicing might degrade in case of a buy-out. Migration to a new system in this industry is a major deal, so they all know they better get the right one.
We are open to talk about "special conditions" in our contracts, but for now we haven't found anything acceptable for us. For example, one company asked for an equity stake, one for an equity swap, two others a seat on the board, another requested that we put our source code in escrow.
We fully understand their concern, but we can't give equity or board seats to clients mainly because their competitors (the rest of our market) would immediately lose interest in the system. Plus, it would be smart to retain as much equity as possible for potential major opportunities down the line, rather than "sacrificing" it for a single client.
What could we offer these key clients to neutralize their concern related to our long-term survival or ability to service them?
Yeah, I used to be responsible for IT (though not in investment banking, so there may be industry specific stuff I don't know) and the only circumstance in which I would trust a core capability to a start up would be to get the source code in escrow.
I'm honestly not sure what other conditions would be acceptable if a large migration would be required to use the software. When you're innovating a business, it's easier to take risk -- "let's try out adding this new business capability and see what happens", but if you are talking about an existing core capability which is central to your financial survival then you want to reduce the risk as much as possible, and you definitely do not want to risk two migrations in a short period of time. In practice, that means that I would often need to choose a less innovative or well built product in exchange for getting (fi) a large and stable client base (means that even if the company gets acquired, they'll still take care of existing accounts) or a very financially sound vendor.
TBH, escrow contracts are a fairly serious/expensive pain in the rear end to negotiate and my ability to exercise when a release event occurs as an IT manager can be quite limited. In reality, a software company would have to be literally fantastic to get me to consider an escrow agreement.
posted by frumiousb at 8:34 PM on September 30, 2015 [1 favorite]
I'm honestly not sure what other conditions would be acceptable if a large migration would be required to use the software. When you're innovating a business, it's easier to take risk -- "let's try out adding this new business capability and see what happens", but if you are talking about an existing core capability which is central to your financial survival then you want to reduce the risk as much as possible, and you definitely do not want to risk two migrations in a short period of time. In practice, that means that I would often need to choose a less innovative or well built product in exchange for getting (fi) a large and stable client base (means that even if the company gets acquired, they'll still take care of existing accounts) or a very financially sound vendor.
TBH, escrow contracts are a fairly serious/expensive pain in the rear end to negotiate and my ability to exercise when a release event occurs as an IT manager can be quite limited. In reality, a software company would have to be literally fantastic to get me to consider an escrow agreement.
posted by frumiousb at 8:34 PM on September 30, 2015 [1 favorite]
Source code in escrow sounds right to me.
posted by slateyness at 8:46 PM on September 30, 2015 [1 favorite]
posted by slateyness at 8:46 PM on September 30, 2015 [1 favorite]
it would be smart to retain as much equity as possible for potential major opportunities down the line
Like selling the company? That's exactly what they're afraid of. (Speaking of which, have you explored selling the entire company to one of the major players?)
posted by Candleman at 10:46 PM on September 30, 2015
Like selling the company? That's exactly what they're afraid of. (Speaking of which, have you explored selling the entire company to one of the major players?)
posted by Candleman at 10:46 PM on September 30, 2015
This is entirely hearsay, so it might not be true, but at one place I worked I was told that the source code escrow measures the company took were compulsory for whatever channel we were using to sell to the U.S. federal government. If there's any possibility you might in the future attempt to sell to a customer for whom source code escrow would be compulsory, it might be an advantage to get all of the practical details around that worked out now.
posted by XMLicious at 6:30 AM on October 1, 2015
posted by XMLicious at 6:30 AM on October 1, 2015
Response by poster: Thanks to all. Since the escrow idea seems to be acceptable for several people here and elsewhere, another question comes to mind: how to share the escrow arrangement between several clients?
My fear about escrow is how to properly define the trigger events, like the incapacity to maintain and develop mentioned by alms (what if we go through a temporary rough patch?) I wish I could see one of those agreements to have an idea if it can work for us...
@Candleman: it's too early for us to sell as we are starting only now to gain serious traction. We had already a few offers, but we are confident we'll be able to grow much larger than what they are willing to pay for today.
posted by caudingo at 7:25 AM on October 1, 2015
My fear about escrow is how to properly define the trigger events, like the incapacity to maintain and develop mentioned by alms (what if we go through a temporary rough patch?) I wish I could see one of those agreements to have an idea if it can work for us...
@Candleman: it's too early for us to sell as we are starting only now to gain serious traction. We had already a few offers, but we are confident we'll be able to grow much larger than what they are willing to pay for today.
posted by caudingo at 7:25 AM on October 1, 2015
how to share the escrow arrangement between several clients?
My offhand answer to the question would be that you make the arrangement non-exclusive, which shouldn't be a problem because it doesn't grant commercial rights. In other words, the escrow agreement gives a client the non-exclusive right to use the software and continue to develop it for their own use; it doesn't give them the right to sell the software.
But for the real answer, and to answer your other questions, you should really talk to an attorney who has experience in the field. As should be clear from this discussion, it's complicated and there are many details that have to be done right.
posted by alms at 7:41 AM on October 1, 2015
My offhand answer to the question would be that you make the arrangement non-exclusive, which shouldn't be a problem because it doesn't grant commercial rights. In other words, the escrow agreement gives a client the non-exclusive right to use the software and continue to develop it for their own use; it doesn't give them the right to sell the software.
But for the real answer, and to answer your other questions, you should really talk to an attorney who has experience in the field. As should be clear from this discussion, it's complicated and there are many details that have to be done right.
posted by alms at 7:41 AM on October 1, 2015
As everyone else has noted, source escrow is often standard operating procedure for business critical software. And it's not just restricted to startups - a lot of my employer's clients have source escrow written into their contracts, even though we've long been acquired by a Fortune 500 company. I don't think of it as a particularly onerous thing - I'd grant this before giving up any equity or board seats.
posted by Calloused_Foot at 12:32 PM on October 1, 2015
posted by Calloused_Foot at 12:32 PM on October 1, 2015
But for the real answer, and to answer your other questions, you should really talk to an attorney who has experience in the field. As should be clear from this discussion, it's complicated and there are many details that have to be done right.
This. These aren't questions you can answer with research online. You need to work with a lawyer who has competence with source escrow. I'd suggest you try to set up one non-exclusive agreement with trigger conditions you can live with and try to cut down on the negotiations with each client.
My fear about escrow is how to properly define the trigger events, like the incapacity to maintain and develop mentioned by alms (what if we go through a temporary rough patch?)
Remember that from the point of view of the customer, they need maintenance on a regular and predictable base even if you are going through a temporary rough patch. But you usually can define it in such a way that you have some time before the trigger trips.
A lawyer is a good investment for you right now if these kinds of key clients are your best hope at success. There are also source escrow companies who may be able to give you a standard agreement so you can start to think. Do you have a client who has asked for it? (Not just tossed it out as a possible condition) If you do, then maybe you can use that client as a base for developing a standard approach-- it will probably seriously crimp your margin for that sale, but at least the cost would be absorbed somehow.
posted by frumiousb at 3:26 PM on October 1, 2015
This. These aren't questions you can answer with research online. You need to work with a lawyer who has competence with source escrow. I'd suggest you try to set up one non-exclusive agreement with trigger conditions you can live with and try to cut down on the negotiations with each client.
My fear about escrow is how to properly define the trigger events, like the incapacity to maintain and develop mentioned by alms (what if we go through a temporary rough patch?)
Remember that from the point of view of the customer, they need maintenance on a regular and predictable base even if you are going through a temporary rough patch. But you usually can define it in such a way that you have some time before the trigger trips.
A lawyer is a good investment for you right now if these kinds of key clients are your best hope at success. There are also source escrow companies who may be able to give you a standard agreement so you can start to think. Do you have a client who has asked for it? (Not just tossed it out as a possible condition) If you do, then maybe you can use that client as a base for developing a standard approach-- it will probably seriously crimp your margin for that sale, but at least the cost would be absorbed somehow.
posted by frumiousb at 3:26 PM on October 1, 2015
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posted by alms at 6:57 PM on September 30, 2015 [12 favorites]