Early stage technology companies that enter partnerships such as original equipment manufacture or reseller agreements with industry 800-pound gorillas (further referred to as the ‘other party’) typically have little or no negotiating leverage. Fortunately, sound advice coupled with tactical decision making has shown to have a positive impact on the outcome of such transactions from the standpoint of company value.
Your leverage in a negotiation is typically driven by a combination of your company’s financial independence and the strategic value of your assets to the other party. Based on these value drivers and a few that are less obvious, here are some ideas to help you be more successful when going up against the other party.
Cash position; have the painful discussion now – As you see a partnership evolving, sit down with your board to discuss your cash position. If you do not have cash to operate beyond approximately six months and your investors are unwilling to support you beyond this time, you may be forced into a partnership that devalues your exit. An injection of capital can be extremely useful at times like this to show the other party your board is not looking at the partnership as the only alternative.
Expect the other party to take full advantage of a weak cash position by demanding provisions in a partnership agreement that block a merger with any other company. Since going public is generally not a near-term option, without investor backing you are faced with shutting down the company, selling the company’s assets or signing a one-sided partnership agreement.
Establish leverage through integration – As early and often as possible, before negotiating a formal partnership, establish leverage with the other party through integration initiatives in the areas of technology, products and sales. Depending on the partner, integration may be driven by a formal program or a technical group that has been assigned to do feasibility studies. If your technology enables a new sales channel, expect the other party’s sales organization to have an extremely important role in a partnership decision making process. In general, your negotiating leverage improves as you develop a strong relationship with an “internal champion” and your technology becomes more integrated within the other party’s organization.
Establish leverage through partnership discussions with the competition – Do not limit yourself to just one partner. CEOs should keep multiple partnerships as a high priority. If one cannot foster relationships with three or more large partners, find at least two suitable partnership opportunities. Few topics will provide leverage in a negotiation like the threat of a competitor or business security gained through deal flow with other partners. Even high level partnership discussions with a competitor can provide you with details necessary to enhance your negotiation position.
Establish leverage through offensive tactics – Under certain circumstances, the other party may be an efficient source of capital for your company as part of a successful partnership. While no structure is “typical,” one approach is to structure a cash advance made by the other party on future sales for up to several million dollars, depending on pipeline estimates. Make sure the advance is structured to be taken down through partial accruals.
For example, you would request the other party to attribute only 50 percent of the value of any particular joint sale against the advance, allowing your company to receive continued cash flows. Position the advance as a commitment you need from the other party to ensure a full roll out or integration of your product and as a means of defraying your costs associated with support, training and services, as applicable. Taking an offensive position such as this shows strength and can be an effective means of developing leverage.
Avoid giving the right of first refusal – There are few circumstances when it is appropriate to sign a partnership agreement containing a right of first refusal tied to a change of control provision. Do not negotiate a provision like this without the advice of an M&A advisor. If you agree to a right of first refusal, you essentially have given the other party an option which limits your alternatives. A keen advisor can still extract value or hedge these provisions through upfront cash payments with tactical legal terms that still provide for certain unrestricted M&A exit scenarios.
The negotiation of a partnership provides an opportunity to create or destroy tremendous value. The use of sound advice as you enter such discussions will help to ensure you create value through options such as having the possibility of an M&A exit develop during partnership discussions.
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Christopher A. Hieb is a senior vice president on the mergers and acquisitions team at WR Hambrecht + Co. in New York. He can be reached at [email protected].