Getting Strategic: Alliances That Click
With increasing regularity, businesses of all types announce strategic alliances, joint ventures or partnerships with other companies. Often, the particular alliance or partnership is touted as a vehicle that will produce significant benefits for both companies.
With increasing regularity, businesses of all types announce strategic alliances, joint ventures or partnerships with other companies. Often, the particular alliance or partnership is touted as a vehicle that will produce significant benefits for both companies. Entering into a strategic alliance is perceived by management of each participating company as a key part of their broader business strategy. While these agreements have often been associated with technology-related businesses, the value of strategic alliances and the issues that arise when putting them into place are equally relevant for non-technology businesses. This article reviews what such agreements try to accomplish, why a company might enter into an alliance and what provisions are typically included in such agreements.
The Role of Strategic Alliances
The reasons for strategic agreements or alliance agreements (the terms are used interchangeably) span the gamut of most conceivable business needs. Typical reasons include the following:
- Facilitating access to key technology
- Developing an alternative to higher-cost internal research and development (R&D) efforts
- Furthering development of new distribution channels
- Leveraging the marketing resources of one or more of the companies
- Paving the way for an equity investment or financing transaction
- Outsourcing non-core functions to reduce costs
- Collaborating on development of a business concept, service or product
- Filling the need for a business partner outside a core territory or home country
A properly structured alliance arrangement can make a great deal of sense for each party involved. Such an arrangement may offer an ideal vehicle to achieve the respective business goals of each party. However, an alliance arrangement that overlooks certain fundamentals may cause more problems than the lack of such an arrangement in the first place.
The distinction between a true strategic alliance arrangement and a look-alike agreement that is labeled as such is often elusive to draw. This is due in part to the differing levels of importance that each party may attach to the arrangement. What is strategic to one party may be business as usual for another. Thus, it is not necessary that both parties attach the same level of significance to the agreement for it to rise to the level of a strategic relationship. As a general rule, strategic alliances are focused on driving revenues or reducing costs, and have as an essential element the concept of partnering with another company in a way that is not business as usual for either organization.
Crafting a strategic alliance agreement that will meet the needs of all participants requires decision-makers and their legal counsel to work closely and to draw upon multiple disciplines, including licensing and intellectual property protection, financing, marketing and distribution methodologies, shareholder agreements and the rules for various business entities. Because of the potentially broad scope, these arrangements are custom-built; cookie-cutter approaches will not work. A particular arrangement may seek to accomplish multiple goals, and each side must listen intelligently to the other party’s expressions of its objectives and then use this perspective to combine components from applicable substantive areas of business and law into a coherent alliance structure.
At the outset of organizing a strategic alliance arrangement, certain matters should be considered. These include defining and communicating goals and objectives, conducting background due diligence, protecting confidential information and deciding the scope of documentation required.
Define and Communicate Goals and Objectives
It is essential to articulate clearly to each of the participants on the negotiating team exactly what the business objectives or goals are in entering into a particular arrangement and what the benchmarks will be for success once the parties commence implementation of the arrangement. This is a variation on knowing the right questions to ask, and you cannot know what questions to ask in this context unless you understand what the key participants are trying to accomplish and why.
Once the business goals are defined, they need to be kept in mind constantly during the process. Too often participants in negotiations lose sight of the underlying goals in the desire to get a deal done. For a business intent on striking a key alliance, walking away from a deal that does not achieve basic objectives may be difficult after investing significant time, but it may be the right thing to do if basic business needs are not met — or cannot be met — by the proposed arrangement.
Conduct Background Review
If an alliance is truly of strategic importance to a company, the company should assure itself that it has the right partner for the mission to be accomplished. Choosing the right business partner is the single biggest factor in a successful alliance, and even the strongest contract will not protect against the problems of selecting an inappropriate business partner. In certain transactions, such as acquisition transactions, engaging in background due diligence is regarded as standard practice. The same should be true with alliances, but because of the less structured nature in which alliance arrangements are approached by many businesses, this component is sometimes overlooked or relegated to an afterthought. The importance of the particular alliance relationship should dictate the level of scrutiny applied to a potential business partner. In the alliance context, there is greater potential for unaffiliated parties to be viewed as responsible for one another regardless of intent, and often even the language used is problematic (e.g., calling one another “partners”).
If not already known, areas for special attention concerning the other party include the financial strength, past track record in other business dealings, industry reputation, recent news, role of key personnel and whether any obligations may interfere with the alliance or require consents. Businesses may look to counsel to assist in this process, and resourceful lawyers can readily access significant amounts of information on key issues (much of it available via the Internet).
One of the first steps to be taken should be to protect each party’s confidential data and materials before significant information sharing occurs. Entering into a written non-disclosure or confidentiality agreement is customary and rarely meets an objection. Related decisions will include whether confidentiality protection should be unilateral or mutual, the scope of confidential information, the duration of the obligations and remedies for breach.
Intermediate Agreement vs. Definitive Documents
The complexity of a particular arrangement ordinarily dictates whether a letter of intent or agreement in principle is executed prior to negotiating definitive agreements. If the negotiation is expected to take a considerable period of time or cover many complex areas, or if several components that are typically contracted for separately are involved in a deal, parties commonly use an agreement in principle. These intermediate agreements provide a useful road map for the business parties and their counsel as they work through the greater details of documenting the alliance. Normally, these agreements provide that they are nonbinding, with the exception of provisions dealing with confidentiality, exclusive dealing, publicity and the handling of fees and expenses. Parties may want such a preliminary agreement to assure them that many of the basic concepts are agreed to before investing further time and expense to negotiate definitive documents.
Types of Strategic Alliances and Typical Provisions
Among the many reasons for entering into strategic agreements, the most common are developing new distribution channels, gaining access to or developing specified technology, making or seeking an equity investment (which is typically tied to some other strategic reason for at least one of the parties), or exploiting a business opportunity that requires the additional resources of a business partner. The following outlines some of the major concerns peculiar to each of these arrangements.
Distribution Channel Arrangements
A strategic alliance covering distribution or marketing matters is probably the most common type of strategic alliance agreement. It may involve a traditional bricks-and-mortar business partnering with a company that has a significant Internet presence to provide services to one or both of them, to leverage each other’s existing distribution networks for their respective products or services or to collaborate on some other aspect of marketing.
These agreements go by many different names depending on the variation and what is sought to be accomplished, including Co-Branding Agreements, Co-Marketing Agreements, Teaming Agreements, Distribution Agreements, Reseller Agreements, Collaboration Agreements, Marketing Agreements and the like. These may be used to target a particular subset of the customers or prospects of each party, to offer a collaborative product or solution, or to direct customers or prospects from one party to another.
Among the key concerns to address in marketing-related alliance agreements are:
- Ownership of customer data
- Duration of relationship
- Usage of trademarks, service marks and logos
- Territorial scope
- Payment and pricing mechanisms
- Royalty rates or referral fees and related tracking/auditing issues
- Performance criteria
- Parameters of exclusivity
- Termination rights and post-termination obligations
Alliances for Access to Technology
Although it is not always the case, technology-access alliances frequently involve a larger company making resources available to a smaller company in exchange for preferred access to new technology. Typically, a smaller company may have developed a key piece of technology (a drug treatment or therapy, software, hardware, a device, etc.) that a larger business may find valuable. As a result, both may seek to enter into an arrangement to provide favorable access to the technology for the larger company in exchange for satisfying strategic goals of the smaller company.
Ownership and treatment of the existing technology and derivative works will be a key concern. Typically, one of the companies will require that the technology be modified to desired specifications. The companies will need to resolve which company’s team will perform the development work, what development milestones will apply, what are consequences of failure to meet the development schedule, and who will own the further developments. The technology owner will also be concerned with the treatment of source code or applicable engineering documents and whether holding such material in escrow is appropriate.
In many cases, a larger business will agree to make a strategic investment in another company, perhaps to ensure access to desired technology, to expand a distribution channel or to obtain a purchase option on the company in which the investment is made. While many strategic investments may be less stringent than what is demanded by traditional financial investors, increasingly the terms sought are essentially the same. Typically, the timing of the investment is highly negotiated. The “carrot-and-stick” approach can be frustrating to the company being invested in, particularly if the investment is tied to completion of technology development or achievement of business milestones.
Assuming that other terms of the alliance are satisfactorily negotiated, major considerations for the equity component include:
– Valuation of the company
– Form of investment (common stock, preferred stock, convertible or other debt or something else)
– Conversion features, liquidation preferences, anti-dilution rights, board seat rights or observation rights, redemption and buyback features, purchase options, registration rights, activities requiring investor consent, voting rights, co-sale rights and information rights
– Standstill obligations, minimum holding periods, transfer restrictions and anti-dumping obligations
– Formalities of securities laws (e.g., investment representations, full disclosure, exemptions for issuance) and accounting treatment
Scope of Documentation
Alliances may be represented by a single agreement or a series of interrelated agreements. As noted earlier, because alliances potentially address many different subjects and seek to accomplish many different objectives, these arrangements defy standardized approaches. What should dictate the level and types of agreements are the goals to be accomplished by the business parties.
For example, if a joint venture is desired, a decision must be made as to the type of entity to be formed, which will in turn dictate a series of related documents. If a corporate entity is chosen for the joint venture, documents that will be needed and which must be customized to encompass the expectations of each party will include: articles of incorporation, bylaws and a shareholders agreement (each of which may contain extensive provisions dealing with preferences, protective provisions, corporate governance and transfer restrictions, among others), a buy-sell agreement, and possibly incentive compensation arrangements or plans. Contracts with one or more of the joint venturers may also be required, depending on the types of contributions or other arrangements contemplated.
In some alliance arrangements, a separate entity is not formed, but a capital infusion is made in an existing company which is tied to specified contractual arrangements. In such a situation, the parties will need to review and possibly modify the charter documents of the company receiving the investment. In addition, because the investment or continuation of the investment may be contingent on performance milestones governed by the principal contractual arrangement, such transactions reflect the characteristics of a combined financing transaction and a major commercial contract. Beyond revised charter documents, a shareholders agreement, a purchase agreement, a registration rights agreement and a proprietary rights agreement, among others, will frequently be discussed. To emphasize the point, in light of the different documentation paths that may be taken to accomplish the same objectives, the business parties and their counsel need to stay attuned to core objectives and structure the alliance accordingly.
What do the parties do if the arrangement simply does not meet their expectations, whether because of inadequate performance by either party, poor results or changed expectations or circumstances? Alternatively, what if the alliance has achieved its objectives and there is no need to continue the arrangement? Agreeing within the definitive agreements upon termination rights and remedies will allow all parties to move forward with a clearer understanding of the boundaries of the alliance.
Parties and their counsel should consider carefully the types of events that justify an exit from the arrangement. Frequently, termination is tied to failing to achieve critical performance benchmarks. In less complex situations, simply providing for termination upon breach of obligations and clarification of post-termination obligations (e.g., return of confidential materials, sell-off rights, transitional data transfers, ceasing to use the other party’s trademarks or technology, etc.) may suffice. In addition to breach of obligations, other exit events might include change of control scenarios, force majeure events, changed circumstances, insolvency or bankruptcy of the parties, management deadlock, passage of an agreed-upon time period or the fulfillment of the objectives originally sought to be achieved.
The following are common strategies arising with exit or termination situations:
- Parties may elect to have put rights, call rights, rights of first refusal or buy-sell provisions
- If buyback or purchase obligations are triggered, valuation mechanisms need to be agreed upon at the outset
- If license or distribution rights are involved, parties will need to provide what happens to those arrangements post-exit
- Provide for transfers of confidential information and proprietary rights
- Determine the applicability of non-competition or non-solicitation obligations
- In certain alliances, asset transfers or liquidation may be appropriate
Making Alliances Work
By whatever name they are called, strategic alliances are increasingly prevalent within the business world. Skilled counsel can add significant value by knowing how to guide a business through the process of reaching an arrangement that works for all parties. Understanding and thinking through the respective goals of the business parties at the outset will allow critical issues to be identified and resolved smoothly and should ultimately result in a strong foundation for a sustainable alliance arrangement.