Venture capital is a high-risk financing tool that can launch start-up companies and possibly give higher returns to wealthy investors or institutions willing to take the gamble. But some VC companies want more than just a high return. Emory University School of Law Professor Nicole Morris talks about a Collaboration Agreement between a VC company and an IT start-up firm, and shows how to protect your IT client from an overly broad collaboration agreement.
Questions in this Episode
- Why is this collaboration agreement unusual?
- How is the right of first refusal clause hindering the IT firm?
- How can you protect your client from too much intrusion?
- Who owns the data?
- When do you start over with a terrible contract?
An Example of What Not To Do
In her law school class, attorney Morris uses this Collaboration Agreement to illustrate what not to do. The contract is only twelve pages long, which is relatively short. But the agreement is filled with overbroad and imprecise language, which can damage the future of the young IT company.
Collaboration on Top of Share Purchase
The start-up IT company has two contracts with the VC firm. The first is a standard Purchase Agreement where, in this case, the VC company is purchasing a 25 percent ownership share of the IT company for $3 million. The parties also executed this Collaboration Agreement for their “mutual benefit.” But, this agreement is much more favorable to the VC company.
A VC purchase agreement for shares is a standard fundraising document. But a collaboration agreement with a VC firm is “highly unusual,” explains attorney Morris.
The Disguised Exclusivity Language
As an example of damaging imprecise language, Section 6 Future Innovations gives the VC firm the “right of first refusal to exclusively collaborate” with the IT firm on any future applications. The right of first refusal is a standard clause in many VC agreements, but typically it is for an offer to purchase or sell something, not collaborate.
The VC company has the right of first refusal to “exclusively collaborate” but the contract poorly defines collaboration.
Attorney Morris poses the question, “What defines a collaboration in this agreement?” Is it one conversation at Starbucks? Or do you need two or three Starbuck meetings before this clause is triggered? This contract never clearly answers that question.
The purpose of a start-up company is to grow. Which happens through conversations and collaborations with others – not just the VC company.
While this agreement feels like an exclusive relationship, the right of first refusal makes it seem more open. It appears as if the VC company is saying, “We just want to take a first look, and then you can go deal with others,” but according to Morris, it is much more complicated than that.
ANY Future Innovations?
The other troubling part about the Future Innovations clause is that the VC firm has the right of first refusal to exclusively collaborate for any future innovations.
But what does that mean? How can you measure this?
6. |
Future Innovations |
| The Parties hereby agree that Venture shall have a right of first refusal to exclusively collaborate, directly or through its applicable Affiliate(s), with Startup to develop any future applications (other than the MPA) of Startup involving new, or any significantly enhanced or improved functionality (excluding enhancements which are merely iterative in nature), with respect to the ordering, dispatching or delivery of construction materials in the Target Markets or the Follow-On Markets (each, a “Future Application” and, collectively, the “Future Applications”), as well as a corresponding exclusive right for a period of six (6) months following completion of each such Future Application with respect to which Venture elects to exclusively collaborate with Startup (as described below) to roll-out such application to all customers in, and to be, along with its applicable Affiliate(s), the only contraction materials supplier to quote for the supply of construction materials in, the Target Markets and the Follow-On Markets during such 6-month periods. |
The contract defines this as “any future application of the Startup involving new, or any significantly enhanced or improved functionality.” Does this include fixing any bugs or doing any updates like Apple continually does to the iPhone? This loosely written contract language causes confusion to the detriment of the IT company.
Data Rights
Data is valuable, and in this contract, the VC firm is getting their hands on a ton of it. Section 7 Data Rights state that the VC firm can get “access to aggregated, anonymized market and transaction-level analytics” generated by the IT firm’s platform.
Attorney Morris asks why the VC firm needs this data and what they are doing with it. Since data has real-world monetary value, perhaps the IT firm should rethink the value of this agreement.
Many jurisdictions, like Europe and California, have different and stringent laws on data collection and use. There is a valid concern about the legality of this clause in those jurisdictions.
7. |
Data Rights |
| (a) During the Term, Startup shall provide Venture, in such format and at such intervals as Venture may reasonably request, with access to aggregated, anonymized market and transaction-level analytics (i.e., without identifying specific customers) generated by the Startup Platform (“Anonymized Data”), including, without limitation, benchmarking data reflecting the performance of Venture’s Affiliates relative to their competitors. For the sake of clarity, Startup may provide Anonymized Data to third parties that are not Venture Competitors, but Startup may not provide Anonymized Data to any Venture Competitor except in the ordinary course of business by virtue of functionality of the Startup Platform available to all users that has been mutually agreed upon by Venture and Startup. |
The Darth Vader Data Request
Section 7(b) Data Rights language gives the VC firm the ability to request data about the IT firm’s other customers.
Attorney Morris says this ability makes the first section on data request feel like a Trojan horse. The VC firm is saying that while you are getting our data, feel free to look around at other customer’s data that might help us and give that to us also. She equates this to a fishing expedition for other client’s data that might be helpful to the VC firm.
The Two-Year Data Handcuffs
The IT company gathers customer data to provide insights and also to offer data-related services to its customers. But Section 7(c) states that for 24 months after the launch, the IT company must provide those data services exclusively to the VC company.This limits their marketing and financial opportunities for the first two years.
The CYA Clause
Section 7(d) calls for the IT company to comply with all laws in all relevant jurisdictions. This includes all laws regarding data collection and use. Attorney Miller calls this the CYA part of the contract.
But, ironically, it appears to make the document self-conflicting. The document tells the IT company to follow all laws, but it gives the VC company access to other persons’ data. Morris calls this very troubling.
Beware of VC Collaboration Agreements. Find out Why. #ContractTeardown. Click To Tweet
When is the Contract Bad Enough to Start Over?
Lawyers are in business, and their time is one of their most valuable assets. When is it better to just trash a lousy contract and start from scratch? Morris agrees that you should tear down any contract that is so bad it could cripple your client.
But she also teaches her law students to think of it as creating a master template. Keep the good clauses and clean up some of the bad ones so you can have some phenomenal clauses going forward. The next time, if you are looking at contract drafting from an ROI and value-add perspective, she explains that you should probably not write it from scratch.
She advises contract drafters to think of what your clients really need and only include those clauses to protect them – and nothing more. There should be no confusing or contradictory clauses. Your contract clauses should support and enhance each other and clarify the agreement.
Learn From Bad Examples
If you are reviewing or drafting a collaboration agreement, you may want to consider the following points taken from this example:
- Be succinct. Avoid confusing and contradictory clauses that can damage your client’s position.
- Watch Out for Hidden Obligations. It might look like a right of first refusal clause, when it actually obligates your client to an exclusive collaboration agreement. It might look like you are sharing your data, when the clause calls for you to give access to customers’ data.
- Be Wary of Future Giveaways. Watch out for giving away future rights, like the rights to future innovations.
- Data is Valuable. If you are sharing data, be sure you are compensated fairly for it.
- Data laws are complex. Data collection and usage laws are different in different jurisdictions. Be aware and draft accordingly.
- Be Careful of Time Handcuffs. In this agreement, the IT company was stuck with a 2-year handcuff before they could sell their data services to others.
And, if the contract you are handed is terrible, you can use it as an opportunity to build a master template using clauses to fit your clients needs and also protect them. Great clauses build great contracts.
Show Notes
THE CONTRACT: Venture Capital Collaboration Agreement
THE GUEST: Director of TI:GER (Technological Innovation: Generating Economic Results) – an innovative partnership between Emory and Georgia Institute of Technology (Georgia Tech) that brings together graduate students in law, business, science and engineering to work on ways to take innovative ideas from the lab to the marketplace. As a Professor in Practice, Nicole’s areas of expertise include patent law, patent litigation, IP licensing and strategy. You can find her on LinkedIn or on Twitter.
THE HOST: Mike Whelan is the author of Lawyer Forward: Finding Your Place in the Future of Law and host of the Lawyer Forward community. Learn more about his work for attorneys at www.lawyerforward.com.
If you are interested in being a guest on Contract Teardown, please email us at community@lawinsider.com.
Transcript
Mike Whelan [00:00:01] Hey, everybody, welcome back to the Contract Teardown Show, I’m Mike Whelen. The purpose in this show is to hang out with really smart friends like my buddy Nicole Morris over here to tear about contracts and talk about things we like and that we hate and want to make fun of in a public forum because we can. So today we are talking about a collaboration agreement. Nicole, how are you doing today?
Nicole Morris [00:00:24] I am well, and I’m actually excited about Christmas in the pandemic, despite it being Christmas in a pandemic.
Mike Whelan [00:00:32] You’re a monster. I don’t think we’re ever going to finish decorating our tree. That thing has been up. It took like four days to get it lit. Now, there’s not stuff on it. It’s never going to get done. I do love, though, every time I ask somebody in this pandemic, how are you doing there? Like. Oh, OK, so today, guys, we are going to talk about a collaboration agreement, and this is an interesting one because Nicole uses it in her law school experience. It is this document. There are a couple of parties. We’ve vague out the names and we’ll talk to you about why. But you’ve got an agreement between an IT startup and a venture capital company. This thing is fairly short. It’s got a lot of really cool Latin words in it and we’ll talk about it. So, Nicole, tell me, why are we talking about this document? Why is it significant? Why should lawyers care about this particular contract were tearing apart?
Nicole Morris [00:01:27] Yeah, this is a great sort of typical startup agreement. As Mike indicated, it is short. It’s like 12 pages, which in lawyer land that’s really short. And it has all of the things you want to see in a collaboration startup agreement. When you read through the language, you realize it’s a lot of words, but it’s not saying anything and it’s not helpful. So I thought it would be great to do a tear down on.
Mike Whelan [00:01:56] Yeah, I’m going to share this thing again because it’s hilarious. But before I do, Nicole, tell me about you. I mentioned that you’re in the TEACHE space. Tell me more about your background.
Nicole Morris [00:02:06] Yes. So I am a professor at Emory Law and I’m also a director of this entrepreneurship innovation program that we have in partnership with Georgia Tech. So we work with innovators in the Atlanta area and we help them frame out whatever it’s usually technology innovators. We help them frame out where their technology fits in sort of the innovation equal ecosystem, so to speak. So what’s their value? What are the intellectual property rights they should consider? How can they go to market? And the law students work as consultants. And then there’s also some class and academic time that we do to teach everyone in the program how to do this work.
Mike Whelan [00:02:50] Yeah, and I think you mentioned to me that this one actually came from the teaching experience. And here’s why I’m sharing this thing again, because I just think it’s so awesome. The first recital venture, we’re again generalizing to the venture startup and the the venture capital company and the startup company venture is contemporaneously here with investing three million in startup in exchange for a 25 percent ownership interest in startup pursuant to and on the terms and conditions set forth in that certain series A units purchase agreement of even date here with the purchase agreement and the other documents referenced therein. I love this so much because it’s like if the Dilbert guy was going to write a contract, this is what it would look like.
Nicole Morris [00:03:37] This is pretty much like contract bingo for what you shouldn’t put in a contract. And how many words can I use that really are unnecessary and add no value to the document?
Mike Whelan [00:03:49] And we are going to jump there. In fact, we are going to jump the area and go down to a couple of parts that I think are interesting. Can you tell me I gather and tell me if this is right, that there are two companies here and one is like an IT services company and the other one is a is a money company? Did I get that right so that the company that’s doing the selling there, are they doing software or are they a services company.
Nicole Morris [00:04:20] Yeah. So the startup created an app, so this looks more like an I.T. service that they’re providing and they are collaborating with their bank, so to speak. Right. So the firm is investing in the operation, but this agreement is the collaboration agreement that they have agreed to with the VC firm, which also, I should point out, highly unusual. Hmm. Usually the VC firm is literally like your ATM. We just want to get money from you. We want you to leave us alone while we go. Bill, do you can come check in because we understand you want you care about your investment, but you’re not my collaborator. I’m going to collaborate with a third party. That’s what makes this also an interesting agreement to look at. But we’re going to take a look at two of the clauses that I think are problematic.
Mike Whelan [00:05:16] Yeah, I know that, you know, on that, like them getting intermingled into the business, we’re going to jump down to six and seven. And it’s because it has to do with, you know, the inventions, with the product of the work of this company that, you know, normally they’re not this entangled. So let’s jump down to six. It talks about future innovations. And this is a heck of a paragraph, but it just starts that the parties hereby agree that venture shall have a right of first refusal to exclusively for what was it, a twenty percent stake in my remember and write. 25 percent exclusively collaborate directly or through its applicable affiliates with startup to develop any future applications, and it goes on. What about this paragraph is standing out to you?
Nicole Morris [00:06:02] Well, they have the right of first refusal, which by itself is OK, but it’s the right to collaborate. So normally when you see a rider first refusal, it’s for an offer, right? For a purchase or sell or something like, look, we want to get in on that deal first, but it’s this right of first refusal to collaborate. And the problem is it’s our future innovations and they define collaboration very poorly. So if I have a conversation with you at Starbucks, think of it as pre pandemic where we can actually go and inside it. Right. But if I. Is that a collaboration? Do I have to have two or three conversations with you in order for it to trigger this clause, like the events that would trigger to me are problematic? And as a start up, you don’t want to be handcuffed so strongly that you can’t even collaborate. I understand you don’t want us to enter into another agreement, but can I talk to other parties? Like that’s your whole point is to start if you’re trying to grow your business. So it feels very much like an exclusive relationship. Even they’re saying it’s a right of first refusal. Right. So it sounds more open, meaning we just want to know. So then we can say, no, you can go on your way. But it’s really more entangled than than it looks on the on the outside.
Mike Whelan [00:07:38] And there’s notice provisions in here. You know, they’ve got to let them know within a certain amount of time. And then, you know, they’ve got 30 days all written notice. And then if they don’t get a response, they can go ahead and collaborate with such other party as it determines with respect to such future application that it really is a relationship that seems, you know, pretty this feels like a joint venture, not an investment.
Nicole Morris [00:08:07] It very much looks like and sounds like a joint venture opportunity and not an investment. And it’s the collaboration that the VC firm is trying to protect. Right. So the language of the agreement is written very much to protect the VC firm and their interest from being, you know, well, I guess essentially diluted. But the startup running around with a bunch of other companies and forming other relationships, one of the other troubling parts about this clause is, OK, so they have the right of first refusal regarding any future innovations. But what does that mean? So any future innovation that significantly enhanced or improved functionality? Well, how do we how do we measure that? So if is it, you know, like my software updates on my iPhone, is is that a significant enhancement or improvement of functionality or is it just to fix some bugs? Right. Which is what Apple always says or fixing some security bugs. Would that be a significant improvement in functionality? So the terms are loosely defined where I think the startup, essentially anything anytime they talk to anybody, they’re going to have to get their VC firm to approve it. That’s how I would interpret it. If they if I were in-house counsel and, you know, I’m on vacation and they come back and they say the is what we signed this agreement. We were trying to move fast and save you some heartache. And I just go hit my head against the wall.
Mike Whelan [00:09:50] Well, and this this addresses getting to seven, a theme that has come up a lot with modern contracts, which is data rights that there’s there’s data that’s being generated in the operations of each of these companies. So we’re looking at a it talks about it says that startup will provide venture in a format. That venture wants access to aggregated, anonymized market and transaction level analytics generated by the startup platform. Again, data is worth a lot and it seems like venture cut this venture companies really getting their hands into it. What do you think about this section A?
Nicole Morris [00:10:28] So section A sadly I think tends to be common. So this data right section I think is it starts off as what you would expect to see in the data rights exchange between two parties. But what’s troubling is why does the VC firm need anonymized market and transaction level analytics? So, you know, again, I’m questioning you’re collaborating with your v.C and the VC is asking for a ton of stuff from you. What are they doing with this additional information? And should you value their investment differently because they’re getting additional value from you that you’re not really monetizing correctly? And then the one thing that I thought that triggered you would need some further sort of vetting and diligence. Does this data clause satisfy sort of some of our national jurisdictions, so California comes to mind, can you do this under California law? I don’t know, but it just triggered a bunch of other obligations on the part of the startup.
Mike Whelan [00:11:46] Yeah, or Nevada or theoretically, if they have international operations, the GDPR. And relatedly and B, it talks about not not just anonymized data about the performance of the specific thing that they’re creating, that they’re entering into this agreement on. It also says such specific data relating to customers of Venture and its affiliates, including the business performance of VENTURE and its affiliates, and it adds this nice little sentence at the end for the sake of clarity, because clarity is clearly one of the strong suits of this document. That was my sarcasm emoji. I don’t know if you saw that startup may provide similar data that relates solely to the customers of any other user of the startup platform for a similar internal use by such other user. That was a heck of a sentence for clarity. What do you think about B?
Nicole Morris [00:12:35] Oh my God. B is a train wreck. So that last part just it feels like a Trojan horse. It’s like while you’re in there looking at that data, if you could just kind of get me some data from, like my people and then, you know, if you see anyone else’s data, you think that I might want for the sake of clarity, just send that on as well as like, oh, OK. And this is one of the things that, you know, that consumers hate about contracts. Right. You have to read every line, people every line. So it starts out sounding reasonable. And then you get to, you know, the Darth Vader request at the end and you’re like. And here’s why this contract is bad,
Mike Whelan [00:13:25] yeah, that for the sake of clarity, it sounds like the phrase with all due respect, because when you say that, you know, you’re about to say something terrible and disrespectful and if a lawyer starts in a document for the sake of clarity, you know, whatever’s coming after is a jumbled mess. Speaking of going to C it talks about the during this term getting more data, specific data relating to customers of Venture and its affiliates that they’ll they’ll use these data services, provide insights and data related services to their customers startups shall provide the data service exclusively to venture and its its affiliates and not to any other party for a period of 24 months following the launch of the data service within each target market and applicable follow on market. Follow on market. Right. Or just keeps going. What do you think of C?
Nicole Morris [00:14:14] Yeah. I mean again, you’re getting handcuffed for a two year window after the launch. Public, presumably, excuse me, of the app, but that’s not clear, right? It’s the launch of the data service within each target market and then the follow on market. So it’s for future markets that you’re also obligated to provide exclusively these data insights. It’s very troubling because the this section, based on these three clauses we’ve yet to go to the fourth are are obligating the startup to some significant requirements. And it’s not clear if all those requirements are lawful.
Mike Whelan [00:15:07] Right. And even if the venture companies under the same obligations, if you look at D, it says that the startup hereby agrees. So it’s it’s certifying startup agrees that during the term it is, a startup will comply with all applicable laws in all relevant jurisdictions, startups, privacy policies, industry standard protocols, the requirements of any codes in the jurisdiction. Again, it’s talking about protecting data, but that obligation seems to be really heavily on the startup and the sections before seem to undermine what it’s certifying here. Indeed. What do you think about D?
Nicole Morris [00:15:44] Absolutely, D was just sort of like a CYA, it’s like, oh, don’t forget to tell them to follow the laws that we told them to break and you know, we will follow the laws of the jurisdiction. Idi Amin, if I’m the start up, I you know, I’m praising the I guess because I could say, oh, I can’t do any of this other stuff because he says, I’ve got to follow the laws of the applicable jurisdiction. But, you know you know how this works, right? So, yeah, this this whole section is somewhat contradicting on itself and troublesome on many levels.
Mike Whelan [00:16:27] Well, I wanted to talk to you because, you know, you’re in this situation at the law school where you’re sort of you’re sort of in a clinic. Right. You’re dealing with these local companies and the kinds of contracts that they’re running into. This one came from an actual company that that had signed this agreement. So I wanted to talk to you just in terms of general principles about this issue that we’ve talked about on this show before. The distinction between business clients want to see ROI and any time spent by a lawyer looking through a contract. So you don’t want to spend umpteen hours making a beautiful contract. But in response, you get these not very thoughtful copy paste contracts here with heretofore there in that has all kinds of jumbled stuff in there. So tell me about how you’re teaching the students at the law school how to think through documents like this. Do they do they tear them apart or do they have to? How do they explain to the client it’s worth me tearing this thing apart?
Nicole Morris [00:17:25] Yeah, that’s a great question. So I you know, it’s just answer from the latter point. Yes, it’s worth you tearing this thing apart because these obligations could cripple your company, your organization going forward. But I also advise them to sort of think of it as creating a master template or a master document which to draw from. So some of the good clauses or clauses, if we cleaned it up or change some of the wording would be a phenomenal clause. He is going forward that goes in your master, right. So the next time, if you are looking at it from a ahli and in value, add perspective, you’re not writing an agreement from scratch anymore. Like, I don’t think any lawyer does that today. But you are looking at what is it that my client really needs? And I’m only including those clauses in the contract and I’m including clauses to protect my client’s interests, of course. But that’s it. And you shouldn’t have a clause where it’s like, clearly, we don’t know if this is applicable under any jurisdiction. And then we say, but you have to follow the laws of that jurisdiction. Those conflicting clauses should not exist. You should have clauses that actually enhance and support one another and provide clarity as an overall agreement and not contradict each other.
Mike Whelan [00:18:51] Yeah, I’m not you know, I don’t want to pitch Law Insider’s functionality specifically, though. The bosses might want me to. But, you know, if you go on Law Insider and you look for a contract of a you know, an employment agreement, executive employment agreement for this type of industry, it’ll give you some representative documents. But then you can go clause by clause and side by side, choose from among possible, you know, clauses that could include, you can see highlighted the differences between them. And I think for us, you know, in our schtick, our pitch is that we know you’re going to do some copying and pasting. Right. Nobody’s starting from scratch, nor probably should you in a world of precedent, you know, that would be a little bit crazy, but thoughtfully create, like you said, your master documents thoughtfully create a library of documents as you go through your practice by thinking about these different sections. Don’t just don’t just copy paste. Right. You’ve got you’ve got more obligation than that. So as you’re teaching the students that. So, listen, I want people to be able to follow up with you. Of course, I’m a fan. I follow you all over the place. It’s a little Internet stalky, but you’re so smart. How do people get in touch with you on the interweb if they want to hang out with you?
Nicole Morris [00:20:03] Sure. So I’m on LinkedIn, Nicole N Morris. I’m on Twitter, my favorite new platform, @NicoleNMorris and the number three. And those are probably the best places to get at me. Or just go to the Amarilla website and you can shoot me an email.
Mike Whelan [00:20:21] Awesome. And if you guys want to get access to this document to sort of look through it and find all the Latin words that you didn’t know before, that you didn’t learn in law school, just go to Lawinsider.com/resources will have show notes there. And also, if you want to be a contributor on the Contract Teardown show, just email us. We’re at community@lawinsider.com. And then we can hang out here, too, for thereafter. Thank you, Nicole. We’ll see you guys next time.
Nicole Morris [00:20:48] Thank you.