Exclusivity – Run Away or Embrace?

exclusivity

It finally happened.  You’ve been trying to get the attention of a huge prospective strategic partner and finally they gave you a chance to explain the value you can bring them. In fact, maybe you were fortunate enough to have them come after you (see related article titled “Get the Strategic Alliance Partner to Come After You“). Not only do they understand the value you can offer, but after a couple of subsequent meetings they mention needing exclusivity. You’ve heard from your advisors and read in books to avoid exclusive relationships, if at all possible. But you don’t want to bring the positive momentum to a grinding halt by immediately saying “no”. Where do you go from here?

Is Exclusivity Good or Bad?

First, getting a request for an exclusive relationship can be far more of a blessing than a curse, as long as you play your cards right. Your strategic partner might have just showed you their cards.  They possibly see so much value from the joint relationship that they don’t want their competitors to enjoy the same benefit. But it is also possible they are playing a small game with you, and are just asking for exclusivity because they’re really big and you’re really small. They predict you’ll do whatever they request in order to secure a partnership.

Let’s explore further so that you can hopefully turn this into a great thing.

Start with a Litmus Test for Seriousness

Before you can derive the best negotiating strategy, you must find out how serious these guys are.  How much are they willing to put into the partnership?  Find out.

  • Will they allow the partnership to be announced to the public (website, press release, social media)?
    • If so, will they participate in this announcement or will they simply allow you to do it?
  • Will they engage in co-marketing activities to help generate awareness and market demand for whatever it is the two of you are doing together?
    • Who would be responsible for this? Request a meeting with them.
    • What types of activities would be willing to undertake?
    • How much they would they budget towards the activities? A high-level estimate is sufficient for this purpose.
    • See my related blog explaining co-marketing basics
  • If a joint solution or technical integration project is at the heart of the partnership, what sort of effort will they put in?
    • How many resources and of what type would they put on the project?
    • Who is providing the project management resources? It could be really helpful if your big partner will devote some program and project management resources because they have badass ninjas that know how to do this.
  • Will anyone on their side be compensated (ie – bonus) based on the success of your joint program?
    • I love it when there’s a program or partnership manager on the other side that has money riding on the success of the program.
  • If their sales team has any role in selling what you’re building together, will they give you access to them?
    • Webinars, presentations at regional sales kickoff meetings, a blurb in next sales newsletter, etc.

The types of questions you ask will vary depending on the type of solution you offer and the type of partnership you are entering. But what should be clear is that you deserve to know how much energy your prospective partner is willing to devote to ensuring success if you agree to exclusivity. It is mandatory to at least explore these things before moving forward in the negotiation. It is very unlikely that you’ll get them to agree to all of the things mentioned above, but even one or two of them can be significant to a startup.

I’ll share an even better idea. If you’re reading this article before your prospective partner utters the “exclusivity” word, try to determine what’s described here before they even have a chance to utter the word. If you can get them to commit to a majority of the things on the wish list before asking for exclusivity, then your negotiating position will be significantly stronger.

Protect Yourself

If you determine your partner is committed to the partnership and you’re willing to entertain an exclusive relationship, you should still try to protect yourself.  After all, price and terms are negotiated hand-in-hand (see related article titled “Tell Me Your Price and I’ll Tell You My Terms“).  Consider these ideas:

  • Limit the exclusivity to a specific list of competitive companies rather than anyone or even “anyone in the ___ market”.  The fewer the better.
    • I find that big companies often most care about a small number of key competitors, especially those in the offering category your partnership relates to.
  • Put a time limit on the exclusivity.  You can always renew it if things are going well.
    • I sometimes refer to this as giving your partner “a running start” against their competitors. After all, if your partner is the first to take a risk with you, they possibly deserve at least a running start.
  • Make the exclusivity subject to business results (get specific) and/or important milestones (get specific).
    • I almost always insist on this. If the targets for continuing exclusivity are annual, they probably should increase each year. And maybe you only give such targets for the first two years (allowing exclusivity to extend through the third year if the second-year target is met).
    • One year is a long, long time in the life of a startup. Because of this, I often add a 6-month milestone for the first year. For example, if the first year requirement for extending exclusivity into a second year is $1M (revenue to you from the partnership), consider a 6-month milestone of $300-350K. If they don’t reach this milestone, they lose their exclusivity as they enter the seventh month. This will further ensure they devote energy to the launch and early promotional activities.
  • Limit the exclusivity to a specific geography (ie – country)
    • Even big companies are usually dominant in a particular geography, which means their influence isn’t as great in other geographies.
  • Limit the exclusivity to a specific application use (use case).
    • This works well if your solution applies to multiple use cases and your prospective partner only, or mostly, only cares about one of them.
    • It can be helpful if there are limitations that can be implemented in your product/technology to help enforce this use case restriction. If not, don’t worry too much because you’ll have legal protection from the way the agreement is written (if you have a good attorney).
  • Ask for exclusivity in the opposite direction
    • Your partner can’t strike similar deals with your chief competitor(s)

By the way, maybe it’s obvious but you should make an attempt to combine multiple of the above protection mechanisms rather than thinking you have to just select the best one.

It is OK if the early negotiations are between you and your business-minded counterparts. But once a legal agreement enters the equation, it is very important to have an experienced commercial contracts attorney at your side – especially if your prospective partner is large. Commercial contracts is a sub-specialty within the field of law.

Tying Your Hands (on purpose)

If you predict that one of the leaders in your industry might want to partner with you and is also likely to ask for exclusivity, you could make an attempt to “tie your hands” ahead of time.  Do this by securing partnerships with other companies in the same industry.  These can be small or mid-sized partners, and you don’t need a lot of them.

Imagine being able to tell the dominant player in the industry “Sorry, we can’t do an exclusive deal because we already have business relationships with ABC and XYZ.”  If ABC and XYZ are #5 and #8 on the market share list respectively, they won’t be a big threat to the dominant player, but they are big enough for you to be able to say that neither you, your investors, nor your board members would be supportive of terminating those relationships. Doing so would need to come with some serious performance commitments by the dominant player.

Commercial Terms

Even if you are able to negotiate some of the items in the protection list above, agreeing to exclusivity can also come with more favorable commercial terms for you – most commonly, a higher price. That’s not as much the case if your new partner agrees to significant performance milestones. If not, try to combine some of the previously-mentioned protection mechanisms with a higher price for your product/technology than normal. Remember that when you grant exclusivity, you are giving up opportunity and because of that you should be compensated.

Another tool to consider is to get your partner to pre-pay for a certain amount of your product. For example, if their exclusivity is tied to a $350K milestone at the six-month mark and $1M at the one-year mark, see if they will at least pre-pay $350K. It will feel like non-dilutive funding to you and will further demonstrate your partner’s commitment to the relationship.

Yet another tool to consider is to get your partner to cover unique costs you will incur as a result of the partnership. This often relates to engineering efforts for special features and capabilities you must build that you otherwise wouldn’t (or perhaps wouldn’t pursue for a year or more). It’s called non-recurring engineering (NRE). You can read more about that in my article titled “Get Your Strategic Partner to Fund Your R&D“.

What if You Get Acquired?

Offering broad exclusivity could be an issue for a potential future acquirer, specifically if they compete with your new strategic partner.  Rather than kill some of your future acquisition options, negotiate an option to dissolve the exclusivity. Your ideal option is to be able to terminate the exclusivity with ___ months of notice in the event of a change of control (ie – acquisition).  How many months is fair? Well, it depends on how long your partner needs to viably replace your technology with something else.  In some cases, this might be 3-4 months and in other cases it could be 1 year. But at least your future acquirer will see a path to unwinding a relationship they don’t want.

A less desirable option, but certainly better than nothing, is to have a buyout right. In the event of an acquisition, your acquirer has the right to pay money to your strategic acquirer to terminate the exclusivity. How much they must pay is something you’ll need to negotiate, and it’s possible that rather than a pre-set number up front, it will be a formula based on a prior period of performance. Essentially, your future acquirer will be paying them for the “pain” they would experience if you suddenly terminate their exclusivity.

It is also possible you will combine the above two options into something that might look like this: Exclusivity buyout at a price equal to license fees paid to you over the past 6 months and termination of the exclusivity 9 months from the date of notice. Hopefully you also have some ability to terminate the contract altogether, even if the notice period is long (ie – 1 year). Basically, like was mentioned before you want a way for your acquirer to “unwind” the relationship if it’s not in their best interest.

Summary

If your partner isn’t willing to leverage their size and scale (see the first list of items) and if they aren’t willing to let you have any protections (see the second list of items), you possibly want to run away from the exclusivity request. That doesn’t mean run away from the partnership. It just means don’t agree to exclusivity. And if they say they will only enter into a partnership if there’s exclusivity, you just might need to call their bluff.

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