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Thursday, May 31, 2012

Selling Your Soul, It May Be OK

I was asked to comment on a Quora question relating to partnering with a large company.  The question related to the fact that a single large company wanted to become the sole source sales and marketer of a product of a small company.  In addition, the small company was to turn over all current customers to the large company.  This can work, but great caution is required in the drafting and management of the deal and relationship.  As with any scenario, all of the aspects of the business require review before making such a business deal.

Entering a relationship with a single customer comes allows for both positive and negative issues that may arise in the future.  In drafting the deal, it is essential that the small company consider a wide range of issues that relate to the future of their business. This requires reading the tea leaves a bit since you are drafting agreements to cover potential future activities.  The two key goals must be to end up with the correct financial arrangement for the small company and protect as much as possible the future of the company.  You may derive some protection by ensuring:

1. The agreements making them the sole source agent carries the financial incentives you desire i.e, you make adequate money to make it worth your efforts,

2. You obtain guarantees on total annual sales or you get the product and all customers back i.e. claw-back arrangements,

3. You do not have restrictions on other possible products you can make in the future, and

4. Non-compete on products other than the one partnered are not forced on you.

These are not the only considerations there will certainly be conditions that are more specific you and your counsel require to protect your company.

On the negative side, the sole agent purchasing your product now controls all your business and potential future cash flow.  This assumes you do not have many other products in the pipeline.  Companies often will do a less than favorable deal to receive cash on product number 1 when many other opportunities are in the pipeline.  The cash flow you receive will help you fund the development of other products in a non-dilutive manner. 

The Quora question highlighted the fact that the small company did not have sales and marketing experience.  This is common in many small companies.  It is important to keep in mind that with cash coming in the door, the small company will be able to hire marketing and sales people and build better infrastructure.  One consideration is whether the small company can arrange in the deal with the large company, the ability to share the sales and marketing for a higher percentage of the profit as the small company grows.  The newly developed cash flow and developed infrastructure will allow the small company to become more independent in the future.

One issue to guard against is giving your only product to someone else.  Small company can become a slave to the larger company.  Many entrepreneurs strive to have ability to control their future.  This does not happen when the large company controls everything.  In fact, perhaps small company can structure the deal to force a acquisition of the small company.  In this case, getting liquid on your equity will allow you to start a totally new company.  Just a thought!