Partnering Between Established Companies And Startups

Well-established companies thrive by accumulating capabilities, including by partnering with start-up companies. In those partnering arrangements, the established company often has greater capabilities, market access, technology capital and management skill in all areas but one. But, the startup is among the best in the world at that one area. That one area may, for example, be an emerging technology, an innovative product or a loyal customer base. The deal, then, is for the established company and the startup to share, in some ways, the risks and rewards of attempting to grow a business in the startup's area using the established company's capabilities.

In this chapter, we provide suggestions for both established companies and startups to facilitate these deals. These suggestions include, for the established company, understanding the value proposition of the deal, using approval processes to the established company's advantage, and using contract provisions to mitigate the risk of a startup's financial failure. For the startup, these suggestions include establishing clear objectives and communication (including around capability gaps), educating the established company about the startup's characteristics and being efficient in contract negotiation and drafting.

GENERAL CONSIDERATIONS FOR ESTABLISHED COMPANIES

Established companies will typically have a sizeable market share, a widely recognized and highly valuable brand in the industries in which they operate, and significant resources. These companies also typically have substantial in-house legal and procurement teams and standardized processes and playbooks that prioritize stability, predictability, risk mitigation and compliance. All of the foregoing have tremendous value to established companies, especially to those that operate in regulated industries, and are well designed for contracting with other established companies and even for working with startups as transactional vendors. When applied to partnering with a startup counterparty, however, these processes can sometimes become stumbling blocks or even roadblocks.

We have seen these strategies succeed for established companies trying to negotiate quickly, but effectively, with a startup for a partnering transaction:

• Understand the value proposition and what the startup wants. In any startup partnering arrangement, an established company will likely bear a lot of the risk (including in the eyes of the company's regulators, customers, employees and the general public). In light of this, an established company should have a very clear understanding of the unique value of any partnering arrangement. The established company should also understand the value of what the startup will gain from the established company. Armed with those understandings, the established company can determine whether the risk of contracting with a startup (which may have limited experience and assets) is justified.
• Understand the startup's plans. The established company should understand the startup's long-term plans and whether they are consistent with the partnering arrangement and the established company's strategy, brand and ways of working. Even if they are, the established company should not rely on those plans or the startup's management being in place for an extended period as the basis for doing the deal.
• Conduct due diligence. Conduct due diligence early, including from a legal standpoint to verify the startup's readiness to contract, financial wherewithal, past legal difficulties and capabilities on basic organizational matters (such as having written IP and confidentiality agreements with employees, if applicable). It will be easier to avoid signing an ill-advised deal if issues are surfaced early in due diligence, before time is wasted on negotiations with an unworthy or incompatible counterparty.
• Use term sheets before moving to a definitive agreement. Term sheets can be useful in communicating deal concepts to startup executives with limited experience on deal issues, particularly if the startup's counsel is not familiar with similar partnering arrangements. In any event, a term sheet can avoid large investments in deals where the startup is unable or unwilling to agree to fundamental requirements for the established company. Common examples include regulatory, third-party contractual, operational and technical requirements.
• Communicate openly about requirements and policies. A startup may not be able to meet all of an established company's requirements or policies when the parties begin evaluating a potential partnering arrangement. It can be helpful for an established company to leverage its experience negotiating or partnering with other startups to identify any "show stoppers" in advance, and thus not spend extensive time negotiating if those issues exist. As a corollary, the deal team should also be on guard for attempts by the startup to evade the company's policies and compliance requirements via "end arounds" with friendly company executives.
• Take advantage of the approval process.Duringnegotiations, the established company's deal team should be clear about the limits to its authority and the need for approval from more senior management and stakeholders. While those processes prevent the established company from working as fast as the startup, they also allow the established company to benefit from the experience and knowledge of its strong network of stakeholders and approvers.
• Use contract provisions to mitigate the risk of a startup's financial failure. Many agreements will contain an insolvency termination right, but that may not be practically useful or enforceable upon the startup's bankruptcy. Rights to regular financial reporting from the startup, coupled with an exit right if the startup fails to meet minimum criteria, are likely to be more valuable.

GENERAL CONSIDERATIONS FOR STARTUPS

Startups are typically resource-constrained with an almost all-encompassing focus on product-market fit, growth and market access. In addition, some startup companies are extremely focused on positioning themselves for their next funding round, perhaps leveraging the established company's name. That may lead them to agree to terms with established companies that are impossible for the startup to comply with and that may actually stifle a startup's growth. Here are a few simple tips and strategies for a startup when dealing with established companies:

• Develop trust. Perhaps nothing will go so far to open doors and complete a deal as developing relationships of trust with the right people at a counterparty. Businesses are run by people, and people are more willing to do business with people they like and trust. So a startup should be willing to invest the time necessary to develop personal relationships with contacts at the established company. That trust may be built by clearly and succinctly articulating the value proposition being offered (e.g., an innovative product or technology, unique market insights, cost savings or extraordinary customer service). Once a representative from an established company understands the value proposition of the startup, and a relationship of trust has been developed, those people can help advocate for the startup and their influence can go a long way in helping to get a deal done that is mutually beneficial for both parties.
• Communicate openly about the established company's requirements and policies. Not all gaps between the startup's capabilities and the established company's requirements and policies will be deal-killers. In some cases, the company may determine via stakeholder conversations that an exception to those requirements or policies applies, or the parties may be able to partner on closing gaps and mitigating risks. Open and candid communication from the startup may build trust and a sense that the parties are working together to solve a problem and counteract established-company perceptions that the startup is not prepared for the partnering arrangement. Startups should strive to be agile in responding to unanticipated regulatory requirements and other constraints that established companies have under their existing contracts and internal policies.
  • For example, contract terms related to data privacy and security often prove to be an area where such candid conversations may prove helpful. Data breaches are one of the more costly risks facing established companies that hold or control immense amounts of data. Some data security requirements must be implemented before signing, but some requirements could have longer time frames (e.g., three months after signing or prior to go-live of the applicable platform or solution). Both parties would benefit from transparent discussions about the startup's true capabilities. The startup may be able to offer various compromises to give the established company comfort. For example, the parties may agree that certain fees will not be paid until requirements are implemented, credits will be paid to the established company if the requirements are not implemented on time, or that the established company will have a right to terminate the agreement if there is an extended failure to implement.
• Establish clear objectives (and communicate). While a startup is unlikely to have invested in detailed playbooks and policies, a startup should at least go into each negotiation with a clear understanding of its objectives. A startup can get into trouble if it loses sight of its long-term goals and business objectives in the face of short-term opportunities. Furthermore, a startup needs to be able to differentiate between the nice-to-have provisions and the must-have provisions in a contract.¹
  • For example, a startup must carefully consider term length, rights of termination, purchase commitments and exclusivity with an established company counterparty. Startups often seek longer terms with purchase commitments, whereas established companies may seek shorter terms with a right to terminate for convenience. Conversely, if an established company will use a startup solution for key revenue generation, the established company may prefer a long-term contract coupled with certain exclusivity rights and even most-favored pricing. Although granting exclusivity or similar rights may lock in an established customer, the same may ultimately lock a startup out of potential growth markets. In any case, clauses related to term length and purchase commitments are critical to the life and vitality of a startup. Creative solutions can often be found when each party is willing to establish and communicate objectives.
• Educate the established company about the startup's characteristics and how they relate to company policies. Established companies benefit from standard playbooks and processes in negotiations. However, those are often designed for negotiations with established companies or a different type of startup company.
  • A startup may need to explain that a market-standard term in an agreement between established companies may not make sense when the counterparty is a startup (for example, if the total assets of the startup are worth less than the dollar amount of a "supercap" on personal data liability recommended by the established company's playbook). These explanations can help the company's deal team acclimate their stakeholders to the tradeoffs between access to the relevant technology and risks that may be inherent to a deal with a startup.
• In contracting, less can be more. Despite a startup often needing to work within an established company's playbook or standard form document, targeted edits to a contract that accomplish the startup's objectives with a minimal amount of revision can be a better, faster way to make a sale.
• Seek creative and flexible solutions. A contract is rarely a zero-sum game. A startup should listen carefully to understand the interests and demands of the established company and then use that knowledge to find a solution that both parties can live with. The startup likely has more alternatives available to it because it is constrained by fewer existing contracts and relationships.
  • For example, sometimes an established company is more interested in the features or functionalities of a technology, or about flexibility in contract terms, than it is in price or other terms. If a startup understands those things that are important to the established company, it can use that knowledge to find a way to get a mutually beneficial deal done when it may not have otherwise.

CONCLUSION

Contracting and partnering between established companies and startup companies present unique challenges and opportunities. By understanding each other's needs and constraints, fostering a collaborative spirit and carefully negotiating key contract terms, both parties can create a partnering arrangement that drives innovation, sustainable growth and mutual success. As today's business landscape continues to evolve, these collaborations will likely be increasingly crucial in harnessing the strengths of both established and startup companies to navigate complex markets and achieve desired outcomes.

Footnote

1. For a general discussion on contractual issues startups should be wary of, see Glende, S., Young, S., and McPherson, J. "Proactive Contracting for Tech Startups: Will Your Commercial & IP Agreements Help or Hinder an Exit?" 21 December 2023, https://www.mayerbrown.com/en/insights/publications/2023/12/proactive-contracting-for-tech-startups-will-your-commercial-and-ip-agreements-help-or-hinder-an-exit.