3.3 CAN WE LEVERAGE OUR CLIENT AS A CHANNEL WITHOUT CONVERTING IT INTO A COMPETITOR?

VALUE ADDED LICENSING

General Description

Value added licensing is a term used in this book to describe the startup as a provider of products or services which are not resold on a stand-alone basis but are integrated by the corporate as part of a broader service and product offering.

Objectives

The startup will have the following objectives while offering and selling its products and services for integration into the products and services of the corporate:

• Increase the market reach for the products and services of the startup by leveraging the strategy and business of the corporate and its clients.

• Increase the revenue stream through fees (subscription, license, maintenance and support).

• Take advantage of the expertise of the corporate in various markets and countries, including ensuring regulatory compliance.

• Retain intellectual property rights on both standard and (ideally) custom developed products and intellectual property rights.

The corporate will have the following objectives while procuring products and services from the startup for integration into its products and services:

• Minimize research & development investments by leveraging the products and services of the startup in return for licensing and sub-licensing fees.

• Increase the innovation cycle and offer new solutions to its existing clients, while mitigating innovation development risks.

• Ensure a competitive advantage against competitors by integrating the value-added solution into broader product and service offerings.

Value Added Licensing Best Practices

Scope Definition

Firstly, it needs to be determined whether the startup will only deliver its standard products, or if it will also be required to engage in any custom developments for the corporate for purposes of integrating the products in the integrated solution to be offered by the corporate.

In the event the corporate also commissions custom development work, partners will typically engage in a discussion as to the IP ownership of such custom development work. From the corporate’s perspective it is quite logical to argue that it should own the custom developed products as it has paid for the development and (indirectly) assumes the development risk. From the startup’s perspective, the required outcome depends on whether it needs to be able to re-use the custom developed work as part of its standard products to be offered to other clients. See Section 3.5 on Funded Development for further insights on this topic.

End User License Agreement and Usage Restrictions

Each client of the corporate using products or services containing the integrated technology assets provided by the startup, is to be bound by an end-user license agreement, commonly abbreviated as “EULA”, which provides a contractual framework for the corporate to commercialize the products and services of the startup as part of its integrated solution sold to its end clients.

A EULA typically limits the use of the products of the startup to the corporate and its clients’ internal business purposes. The corporate is not allowed to sell or otherwise commercialize the products of the startup on a stand-alone basis, except as expressly permitted.

It is crucial for the usage rights granted by the corporate to its clients to be no less restrictive than the usage rights granted by the startup to the corporate. Typically, the corporate will be responsible and liable towards its clients for the proper use of the products of the startup.

IP Ownership

For all intents and purposes, the ownership of intellectual property rights on the standard product suite of a startup or scaleup must at all times be retained. Any other construct would compromise their ability to resell their products and services to other potential clients.

This requires the corporate to agree a.o.to the following principles:

• Not to use the products of the startup other than (i) for its internal business purposes, and (ii) to service its clients through the provision of the integrated solution.

• Not to modify the products of the startup or develop any derivative works.

• Not to decompile, disassemble or reverse engineer any products of the startup, including the underlying ideas.

Licensor Roles and Responsibilities

It should be clearly determined which roles and responsibilities the startup has in the provision of technology, maintenance and support services to the corporate and its clients.

It is recommended for the partners to establish a relationship management committee to oversee the relationship, and to meet regularly to review progress of ongoing performance, continuous improvement and other matters of mutual interest. Each party should delegate an executive with primary responsibility for day-to-day management of the relationship. As the relationship deepens, partners should devote significant time to develop a detailed governance model to manage the relationship from a technological, commercial and overall business perspective.

Service level discussions should start from a realistic perspective on the ability of the startup to provide 24/7 support. Using the standard SLA expectations as if one is working with a large technology vendor is likely to pose significant issues for the startup and are likely to lead to disappointment.

Fee Models

The corporate will typically charge a global price for the integrated products and services without charging a separate pricing for the products and services of the startup.

The products and services of the startup can be provided on the basis of different fee models:

• Perpetual model: one-off license fee, including maintenance and support.

• Concurrent user model: license price is based on the maximum number of users which could be using the solution at any given point in time.

• Named user model: license price is based on the total number of individuals in the user population.

• Processor-based model: license price is based on the number of computers to which the software can be deployed.

• Site-based model: a pricing model used when applications are deployed to a fixed location within a client.

• Subscription-based model: periodic payments instead of a lump sum payment.

• Enterprise license-based model: license price is based on the decision to deploy the software across an entire enterprise, used primarily with large, multinational or global customers.

It is essential for business to business software providers to be acquainted with, and to explore the benefits of, value added licensing contracts and the conditions therein to manage mutual expectations and commitments.

Most commonly, the preferred route to market is by partnering with established corporates through the delivery of part of the end user solution. Entrepreneurs do need to take into account the resulting significant dependency on large organizations that by default have long contract cycles and a different perception of time.

In such an environment and from the outset, the discussions can be accelerated by working with a template value added licensing framework that offers the necessary clarity and balance on the working relationship, both in upward as less fruitful scenarios to support the contemplated symbiotic business offering.

Toon Vanparys, CEO Sentiance
Vincent Jocquet, CFO Sentiance

Escrow Arrangements

It is normal for corporates to be concerned about the stability of startups and their ability to honor their contractual commitments. Upon integration of the products of the startup into the products and services of the corporate, such concerns become even more pressing. A failure of the startup to provide the products and services would have detrimental consequences for the ability of the corporate to service its clients, both from a financial and reputational perspective.

It is thus reasonable for the corporate to demand for the source code of the licensed product suite to be deposited with a reputable escrow agent, whereby such source code should only be released to the corporate in the event of bankruptcy or other significant financial problems of the startup.

Liabilities and Indemnities

Contractual negotiations concerning indemnities and liabilities tend to become much more complicated in the event of value-added licensing as compared to simple licensing.

From the corporate’s point of view, it wants to ensure that it has back-to-back indemnity coverage from the startup for the products and services delivered. It will insist upon indemnification rights towards the startup for contractual issues with its clients which are caused by the products and services integrated into its own solution.

From the startup’s point of view, it will have limited or no control over the manner in which its products and services are integrated into the global solution, and the contractual commitments which are undertaken towards the end clients. Its main concern will be to ensure that the back-to-back indemnity is limited to issues which are directly caused by it.

The integration of the products and services into the global solution sold to many end clients of the corporate has a multiplier effect on liability exposure. The EULA plays an important role in providing clear principles in this respect. It is market practice to provide that no supplier should be liable for indirect, incidental, special, consequential, exemplary or punitive damages, including loss of income, business, profits, revenue or anticipated savings, loss of goodwill.

A typical value-added license will exclude any liability and indemnification obligation of the startup related to or resulting from the following events:

• The unauthorized use or third-party modification of the products and services of the startup by the corporate and end clients.

• The use of the products and services of the startup in combination with any other products or services.

• The customized products and services of the startup having been developed to the corporate’s design or incorporating documents, materials, ideas, data or other information, provided by or on behalf of the customer.

• The failure to use the most recent version of the products and services of the startup made available to the corporate.

Audit Rights

In a user or volume-based pricing model, the corporate will be required to measure the usage by its clients of the products and services of the startup. Seen from this perspective, it is quite normal for the startup to insist upon audit rights to control the usage which has been made of the products.

At the same time, large corporates are hesitant for regulatory and confidentiality purposes to give startups audit access and are likely to resist such demands. A reasonable framework should be put in place, with self-certification by the corporate likely to play a significant role.

Termination and Transition

Discussions concerning the rights of each party to terminate the agreement require careful attention, with an appropriate balance to be struck between the interests of the direct contracting partners, but also taking into account the legitimate interests of the end users who are entitled to the continued provision of services.

The corporate will typically refuse to give the startup the right to unilaterally terminate the agreement for convenience (i.e. termination at any time or after a certain period of time for discretionary reasons). Any termination for convenience would expose the corporate to significant problems towards its clients who have procured a global solution of which the products and services of the startup form part.

At the same time, the corporate should understand that insisting on a right to unilaterally terminate for convenience, poses significant issues for the startup. The startup will most likely incur development expenses and mobilize resources which will need to be compensated through a sufficiently long notice period or termination indemnity.

Even in the event of termination by the startup for material breach by the corporate, the corporate will require continued performance by the startup under the breached agreement so as to enable it to continue servicing its clients. At a minimum, the startup should continue to provide services for a defined period of time (e.g. 12 months), and at a maximum, for the duration of the agreements entered into by the corporate with its clients. Obviously, this arrangement requires the corporate to continue paying fees to the startup.

Upon termination of the agreement, the partners should in any event agree a mutually acceptable transition plan. Each party should designate a transition manager that is responsible for the overall success of the transition and who will act as a single point of contact pending the successful completion of such transition.