And what you should do instead

The biggest mistakes I’ve made as a startup CEO, without a doubt, were signing exclusive agreements. Every lawsuit I’ve been involved with were due to the fallout of a failed exclusivity agreement. I will never agree to another exclusivity agreement again no matter how tempting. And neither should you.

When you sign up a development partner, you can guarantee they’ll demand exclusivity for their market. They make a good case for why they can’t invest in developing the product together if there’s a chance a competitor could do the same.

When you sign up a reseller or distributor to bring your products to a new geography you can’t reach on your own, they’ll demand exclusivity. They make a good case for why they can’t invest in promoting your products only to have another reseller eat their lunch.

When a corporate venture capital group wants to invest in your startup, they often demand exclusive rights to the technology for their field, or at least a right of first refusal on acquiring the business.

DON’T DO IT!

You will regret it. You will likely end up in court to get out of it. Here’s why. And what you should do instead.

Exclusive Sales Territories

My first startup developed specialized computer networking equipment. Our market was worldwide. But it made no sense for us to open sales and support offices around the world while we were small. The simple (I thought) solution: sell direct to customers in the US and rely on local partners overseas.

There was no shortage of network equipment resellers selling synergetic gear anywhere in the world. So I visited interested firms, found the best fit in each country, and invited them to be our partners.

As a small and still unknown startup, we needed more from them than a salesperson to close a deal. We needed a real partner to be our local ears and eyes, do marketing and customer support as well as business development. For that, they demanded to be our exclusive agent. It made sense, so I agreed. It was a mistake.

A few worked out well. Some didn’t for various reasons. I was stuck with all of them. My only way out was to cancel the contract at the end of the year, lose the customers they’d signed up and make an enemy that would replace us with our competitor. It would be better to leave them in place and add additional resellers. But the exclusive agreement precluded that simple solution.

There was also another problem. It took a while to realize what should have been obvious — with the exclusive right to sell our products in their country, they gamed the system.

The hardware cost us about $4,000 to build. In the US, we charged our customers $10,000, giving us a profit of $6,000. For the resellers, we gave them a discounted price of $7,000, splitting the margin at $3K to each of us. I thought that was fair.

Many of them, instead of quoting our price of $10K, offered it to their customers at $20K instead. At that price, they lost sales, but the ones they won they made $13,000 profit instead of $3,000. Even if they lost ¾ of the deals, they still came out ahead. We, of course, lost ¾ of our profit.

To get a better deal, some international customers would get quotes from resellers in other countries. When a UK customer bought our product from our Spanish reseller, the local reseller demanded a spiff to compensate for their lost sale (due to their own overcharging). So much for my plan to keep our operations simple by relying on local partners.

We also ran into issues as the company grew. We eventually reached a size where it made sense for us to open our own local offices in a few critical locations. Getting out of those exclusive relationships was messy and contentious.

Exclusive Product Rights

Another startup I led was approached by an industry giant that wanted to combine our technology with theirs to create a new product they would bring to market. Great! They had the customers and the brand name, we had the technology and development skills. What could go wrong with that? We were on the road to the land of unicorns.

They demanded exclusivity for the use of our technology in their market. If any of their competitors could similarly license the technology from us, they’d lose their advantage for the new product. I was too excited to argue. So I stupidly agreed.

Can you guess what happened? I’ve heard this same story repeated a million times.

We spent a year dancing with the giant to help them develop their product. Just as we were wrapping up final QA testing, word come down from up high. A VP somewhere far up in the chain decided this new product wasn’t strategic to their new vision. The people we were working with were transferred to other projects or laid off. And that was the end of that.

Or so I thought. At least we could pick up the pieces and move on developing our own product, right?

Nope. Strategic or not, they refused to cancel the exclusive contract and risk us working with their competition. I asked nicely. They said no. I begged. They still said no. I had our lawyer send a nasty letter. They stopped replying.

They kept one junior employee on the project saying they needed more time to investigate the market and make sure the product met customer needs. They sent us demands for additional features that required rewriting the entire code base. The relationship went sour.

The lawyers here will point out that with exclusivity comes obligation. They can’t just bury your product. They are required to maximize the value for both organizations. However, even the lawyers will admit that exactly what is required is vague. How fast do they need to bring it to market? How much do they need to spend on marketing? Do they need to price it competitively, provide superior support, and continuously upgrade the features? The answer is: there is no clear answer — it’s up to a judge and jury. If you want out of the deal, you have to bring it to court — a long, expensive, energy-sapping process that doesn’t fit the fast-moving, capital-constrained world of startups.

In other words, we were snookered. I learned my lesson. No exclusivity!

Exclusive Investments

Corporate venture capital groups invest in startups that solve problems for their company. Their money and support can be invaluable to a startup. The company may also be looking at the startup as a potential future acquisition target. CVCs are great.

But…especially at the earliest stages when founders have few other investors offering to write checks, it’s not unusual for CVCs to demand that in exchange for the investment, the startup not accept investment from their competitors.

That should always be a simple no, so their fallback position is that if any company offers to acquire the business, they get the right to acquire it at the same terms — a “right of first refusal.”

Any company interested in acquiring your startup will not spend the time and effort required to make an acquisition offer if there’s a RFR in place and their competitor can snatch it out of their hands. That means your only exit is to the company that invested in you, which may not actually want to acquire a non-core business when it can have you solving their problems for free.

What To Do Instead

Your partner demands an exclusive agreement. You’ll only agree to a non-exclusive one. How do you bridge that gap?

For distributor and reseller agreements, the solution is easy: a non-exclusive legal agreement with an exclusive relationship in practice. While the company is small, signing up multiple resellers in any location is counterproductive. Each needs to make enough on our products to maintain investment and mindshare.

So there’s no reason to sign up more than one partner, but the non-exclusive agreement gives you flexibility to add more resellers if things aren’t working out, or if customers are purchasing across territories, or if a particular customer can only purchase through approved resellers that don’t include your partner.

For development agreements, the situation is a bit tricker, but we can’t be limited in who we work worth. If that means we lose some opportunities, so be it, but I’ve never actually lost any deals. The good thing about big companies is that they are arrogant, and in the end, aren’t really concerned about a competitor working with us since they assume their product or marketing will be superior.

For investment, the answer is simple. No. No right to tell us who we can accept investment from. No right to tell us who can acquire our business. Welcome their investment on the same terms as every other venture investor.

Every exclusive agreement promises huge upside in bringing a product to market, reaching new customers, or landing needed funding, but comes with the very real possibility of killing the business if it doesn’t work out.

Most importantly, exclusive agreements put the fate of your business in someone else’s hands, someone with different goals and incentives than yours.

In the end, the only people who really care about your business are you. You need to keep control over the fate of your business without being tied up with exclusive agreements.

The teleportation startup, SüprDüpr, is offering exclusive rights to their teleporters in different cities around the world. The CEO & founder, Dr. Katie Deauville knows that’s a bad idea, but she needs the money to build the teleportation technology. Once the business operational, she has a secret plan to cut those partners out. She’s willing to do whatever it takes to bring her world-changing technology to market. But would she go as far as murdering her Chief Elephant Officer?

Find out in my farcical, award-winning Silicon Valley mystery novel, To Kill a Unicorn.