Third Party Agreement Considerations for Start Ups

The following is an excerpt from The Start-Ups & Emerging Companies Guidebook, a preliminary discussion on best practices and strategies for start-ups and emerging companies to easily leverage.

Once a company’s organizational documents are settled, the day-to-day aspects of the company’s operations must be addressed, specifically interactions with its suppliers and customers. Even though the company may be eager to leap into new and exciting business relationships, the terms of any new agreements should be carefully evaluated as they may have a lasting impact on the business. For example, less favorable terms that the business had initially accepted may no longer be appropriate if a business becomes successful and bargaining power increases or such terms may make the business less attractive to future investors or acquirors. This article will provide an overview of considerations when entering an initial agreement with any third party.

PURCHASE ORDER OR A FULL CONTRACT?

Many companies conduct their business on a purchase order basis without any ongoing commitment from its customers or suppliers. If a company is filling a purchase order it should also include, as part of the purchase order package, a set of its standard terms and conditions. Purchase orders can recite order quantity, any applicable specifications, and payment and shipping terms, and the process can offer flexibility as needed. Purchase orders can be accompanied by rebate and discount programs, if desired, as a way to incentive the continued business relationships.                 

However, some circumstances may favor entering into a more formal contract. This will depend, in part, on the nature of the business and what the company may stand to gain from a contractual commitment.  These contracts can take many different forms, including as a manufacture or supply agreement, a master service agreement, a software as a service or license agreement, and the list goes on. Formal contracts will be used for an ongoing relationship and can be useful in situations when the parties desire to agree to guaranteed quantities or pricing for an extended period of time.

Contrary to a typical purchase order for a specific one-time product, a formal contract will include the negotiated expectations and commitments of the parties, including term, “most favored nation” pricing, subcontracting rights, exclusivity, intellectual property ownership, confidentiality, indemnification, limitations of liability, warranties, termination, remedies, and dispute resolution. More specialized contracts may include additional customary provisions, such as, in the software space, provisions related to required maintenance, updates, installation, and “up time” covenants. Oftentimes, a company will want its terms and conditions to apply to all sales, regardless of whether a purchase order or a formal contract is used.

TERM AND TERMINATION

The term of a contract details the length of time that the parties’ relationship will be governed by the agreement. It is important to consider if the length of the relationship will be time or project based, or if the relationship length is dependent upon a related agreement between the parties. Oftentimes, contracts with a set term will allow for either, or both, parties to renew the agreement for an extended term. Sometimes there are certain conditions that are required to be met, other times the agreement automatically is renewed unless one party provides notice that they do not intend to renew. Contracts with a notice provision detail the process (including whether the notice can be given orally or in writing) and timing (including minimum days and maximum days of advance notice) required for one party to provide notice to the other of either terminating the agreement or renewing it.

In connection with detailing the term of a relationship, the agreement also should specify the termination events or actions of a party, as well as the termination procedures, and obligations of each party upon the termination of the agreement. Frequently, advance notice is required by the party desiring to terminate the agreement. In certain cases, an agreement can only be terminated before its term expires if certain actions, like an event of default, occurs. These events may include items like (i) inaccurate representations and warranties, (ii) unsatisfied conditions or covenants, (iii) insolvency, and (iv) a change of control of a party, among others. In connection with termination for an event of default, the terminating party can be required to provide notice of such default and provide the defaulting party with an opportunity to cure the default before terminating the agreement. Additionally, the terminating party can at times be obligated to pay a certain amount to the other party to the agreement.

For additional information on frequently included material terms in third party agreements, including pricing, exclusivity and indemnification, Continue reading in The Start-Ups & Emerging Companies Guidebook.