Insights

Strategic Alliance Legal Checklist

October 1, 2015

By: John A. Leonard

Three relationships between companies are discussed:  Financial Alliances; Joint Business Agreements and enhanced customers.

1. Strategic Alliance – Financial
   1. Purpose: To obtain substantial funding from a channel partner or customer that may ultimately purchase your company.  Example: Bigco invests $5 Million into Start-up using preferred stock  that converts into 25% of Start-up’s equity.
   2. Legal Issues:
      1. Loss of control through “Protective Provisions.”  Many strategic investment relationships give the investing company the power to veto important decisions – even though the strategic investor owns less than voting control of the Start-up.  Typical decisions that can be vetoed include: liquidation of the company; amendment of Articles of Incorporation; creation of stock with better rights than the investor’s; obtaining a loan over $100,000; increasing the size of the board of directors.  A solution may be to provide that the investor can be bought out at a formula price if it exercises its veto.
      2. Loss of ability to deal with others who may be competitors of the investor.  Once the investor is in the Start-up, the Start-up may not have the ability to form valuable relationships with other companies that are competitors of the investor.  Competitors will not want to help a company that is partly owned by the investor.
      3. Realization that the investor is not fulfilling a promised role.  Whether because of culture or lack of follow-through, or worse, the reasons to partner with a strategic investor may not come to fruition.  For example, Bigco has a large sales force for products and services which are complimentary to Start-up’s products and services.  Since Start-up does not have a large sales force,  both Bigco and Start-up agree upon an investment, and Bigco promise that Bigco will use its sales force to increase Start-up’s sales.  That never materializes or the projected sales goals are never satisfied.  Without the ability to correct the situation or buy out Bigco, Start-up is trapped, possibly strapped for cash, and left to die or sold for a low value to Bigco or another buyer.  A solution is to provide for better documentation of goals/remedies of failed goal (maybe tied to a reduction in Bigco’s stock holdings or right to veto?) and/or a formula buy out.
2. Strategic Alliance – Joint Business Agreement
   1. Purpose:  Entering into arrangements to:
      1. Accelerate growth – could be the first step to a merger or acquisition;
      2. Access critical capabilities with a channel partner such as production,  a sales force, distribution; payment or fulfillment;
      3. Enter new markets (foreign or domestic) or obtain rights to sell complementary products or services for an existing business;
      4. Accelerate or obtain new R & D; innovation or ideas;
      5. Reduce costs or capacity – outsourcing.
   2. Legal Issues:
      1. Equity or Contractual?  You have the choice to set up a separate entity (a corporation or LLC – these are called Joint Ventures) or to enter into agreements.
      2. Terms of the arrangement:
         1. Do you have an agreement in writing?
         2. How is success measured and can you terminate the agreement if not satisfied?
         3. How long is the term of the agreement?  Too short and it may simply transfer knowledge to another party who will terminate.  Too long and it may make a bad relationship drag on.
         4. Exclusive or non-exclusive?  Farmville uses Facebook as its exclusive platform.
         5. Have you protected your IP?
         6. Have you limited damages and remedies?
3. Enhanced Customers for Early Exits or VC Financing Milestones
   1. Purpose: To show customer attraction and retention in order to exit early to a strategic or financial purchaser or achieve a VC Funding Milestone.
   2. Legal Issues:
      1. Since the key is both customer attraction and retention, the legal relationship must have a paid renewal element or upfront license fee with annual maintenance or a monthly  SaaS subscription model.
      2. Switching costs/barriers should be high.  Once a customer, the value proposition or pain of switching should encourage renewal.  For example, data should not be electronically portable – unless it is to a member of your  Strategic Alliance.
      3. For early exits, understand what your potential buyers want and build that company/get those customers.  Start with the end in mind.  Get your lawyer, accountant and investment banker in on the beginning.

This Article is published for general information, not to provide specific legal advice. The application of any matter discussed in this article to anyone's particular situation requires knowledge and analysis of the specific facts involved.

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