Offering Exclusive Rights
A start-up company’s innovative collaboration software, which targeted enterprises and divisions of large corporations, caught the attention of a large, established firm that had a requirement for this software. The start-up software company was cash-strapped, and the large company knew this. The large company offered to purchase the start-up’s products for its own use only if it were granted exclusivity in certain markets and unrestricted rights to modify the software code. The exclusivity was not troublesome at the time, as the start-up company was not targeting that particular market.
The founders of the start-up company had no experience in making decisions of this type, and they were totally outmatched in negotiations by the large company’s attorney, who had deep experience in technology licensing and transactions of this type.
The founders agreed to the terms the larger company demanded.
In the short-term, the results were beneficial. The company had a name-brand customer and money to pay salaries, grow the team, and invest in product development. However, as the company grew, the founders started to think about an exit strategy. They hired an experienced CEO to lead the company to the next level or to an acquisition. After digging into the start-up company’s contracts and relationships, the new CEO realized that the exclusivity they had granted was a show-stopper for any company that might have been interested in acquiring them. Ultimately, to partially mitigate the exclusive, the start-up company was forced to negotiate paying a high price in equity dilution to the large company.
There are certain decisions in a company’s lifecycle that may never be able to be redone and that forever can affect the value of the founders’ stock and the exit strategy options that may be available to them. It may seem innocuous at the time to grant an exclusive in a market segment that a company is not currently addressing, but such a decision must consider the potential long-term impact. Company founders inexperienced in navigating the complexity of these types of decisions should get counsel from experienced advisers before concluding such matters, especially concerning exclusive market arrangements.