Letter Agreements, Do You Trust the Other Guy?

Having operated companies as CEO, I like to tell my law clients that the bigger the contract, the greater the basis for distrust between the parties. With that homily said, a constant source of tension between lawyers and their business clients is whether or not to use a “letter agreement”. First, lets emphasize the key word – “agreement”. It may look like a letter but may be a binding contract. Therefore, be clear in your mind whether you want the letter to be a full expression of your deal or merely a preliminary expression of some of the key deal points.

Second, what is the nature of the business arrangement. Is it a simple single transaction where one side is selling a single shipment of goods with a single payment in advance, or is it a long-term interactive agreement such as the development of proprietary software with multi-year technical support. Generally, the more interactive the contemplated business relationship, the greater the need for contract specificity – i.e. more paper and lawyer time. Your lawyer may help determine how detailed the potential relationship, however, this part of the process should remain firmly under the control of business decision making.

Third, can you survive the other guy not living up to the deal. The local computer store not delivering the desired computer probably won’t put you out of business. However, a small software developer landing a big Microsoft deal can not afford to battle that giant over contract terms when its resources are fully engaged in performing. Remember, it’s David not Goliath that needs the big contract.

Fourth, do you trust the other side. This intangible brings us full circle to my opening comment – “the bigger the agreement the greater the distrust”. If the deal should be handled in a simple letter agreement but you want more details (i.e. protection), consider not doing the deal. Of course, having been CEO, I know this is often easier said than done.

Fifth, is this relationship governed by a standard in the community that may be used to supply details left out of the letter agreement. Often manufacturing details may be established by reference to industry standards. In real estate construction, for example, detail can be supplied by incorporation of established form agreements. It is important in today’s economy not to overuse your lawyer. However, doing-it-yourself just to save legal fees may cost more if the deal goes sour… At least that’s what this lawyer thinks.

Protecting Your Proprietary Software

SOURCE CODE, SOURCE CODE, WHOSE GOT THE SOURCE CODE

Your company has just decided to dump six or seven figures into the development of proprietary software that will automate your order fulfillment process. Your projections say it will save 10 to 15
percent in direct operating costs not to mention giving you a much needed competitive advantage over your arch rival and competitor – “Breathing Down Your Neck, Inc.” Lacking adequate software development skills in-house, your IT staff submits a couple of proposals from software developers experienced in your needs. Having little experience in this area, you ask each of these vendors, Tweedle Dee and Tweedle Dum, to provide you with a written contract proposal. What will it say, what should you ask for, and what are the ways to reach a compromise?

First, break down the process to its components – development, installation, use and ongoing maintenance or upgrade modification. The first three will be part of the software development agreement
(SDA). The last should be covered by a maintenance agreement. SDAs are generally either fixed price or time and materials agreements. In either, but especially in a fixed price agreement, it is
important to make sure the scope of work (i.e. software specifications) is thoroughly defined. Not heeding this warning can lead to costly change orders. Along this line, be wary of too cheap a
price. You may be a good negotiator but not that good. Remember, you do want to go back to your friends on the golf course and explain why the program may have cost a buck but the key to turn
it on cost a million!

Next, you want to make sure that the payment and performance schedules are tied together and well defined. You want a reasonable interim period to test each phase of the project development.
Typically this is around ten days for testing and approval of interim phases and around a month for the complete project. However, this may vary depending upon your project. Who will own the program? Do you have the right to modify (e.g. upgrade) the underlying program? It may be your million dollars, but don’t be surprised if the SDA only grants your company a nonexclusive use license limited by geography and scalability (i.e. number of users). Your next shock comes when your vendor refuses to assign all the rights (e.g. all intellectual property, “IP”, rights such as copyright, or patent for a business process). His response is likely to be that the cost will be substantially higher if he is unable to use your proprietary software to create a more generic platform for sale to other end users. The compromise varies depending upon a number of factors not the least of which is the parties’ relative bargaining position. Things such as obtaining exclusivity of use for your industry or owning all IP rights while granting back to the vendor a license to use the program in non-competing industries are examples of available options.

Another area often appearing onerous in the vendor’s SDA covers the subject of warranties and indemnifications. Understandably, vendors carefully craft these provisions to the point where, from your prospective, they are more properly described as liability limiting rather than affirmative warranties and indemnifications. As a result, many customers wind up with little or no remedy against the developer when Breathing Down Your Neck, Inc. sues for infringement of their patent, copyright, or some other technology rights in “your” program.

Finally, who controls the source code? This is the programming language readable by humans. In turn, the source code is than compiled into an object or machine code readable by the computer. Your concern should be that if the vendor goes out of business, how could you obtain the critical source code so that you can continue to update or maintain the program. Now days, it is not uncommon for parties to agree to place the source code in a source code escrow. Depending upon the activities surrounding the escrow, this can be a costly proposition. On the other hand, this is a potential operational choke point. Just imagine a year or two from now and Breathing Down Your Neck, Inc. is gaining on you, the last thing you want to hear yourself asking is “source code, source code, whose got the source code?” … at least that’s what this lawyer thinks.

Protecting Your Company Assets

Can You keep A Secret?
By Alan M. Insul, Esq.

How many times have you been told “relax, you can trust me”? And how many more times do you actually find yourself handing over valuable company information to a consultant, key employee, or other third party without so much as taking his library card to prove you gave them your crown jewels? Well, for what it is worth, I too may have been a little too trusting when acting as CEO of various companies. Feeling a little less silly now that you know you are not alone? Of course, the real question is how do you protect your company assets.

A company secret can range from customer lists and marketing plans to prototype computer programs and inventions. Depending upon the type of secret protected you may have to disclose this information to people either inside the company or third parties such as distributors. Ultimately you must place some level of trust in those needing access to company secrets. However, it is important that you implement a security system to control the dissemination and use of the secrets. When dealing with employees consider the following:

• Access should be strictly limited to only those needing to know. You may even need to put information in a physically restricted area that require sign in and sign out procedures.
• Any computer terminal access should likewise be restricted based upon password access and perhaps segregated terminals.
• Control or eliminate any copying of the trade secret material and make sure that all paper is shredded rather than simply put into the circular file.
• All confidential material should be conspicuously marked as such on each page. Instruct employees as part of their employment manual and with posted signs not to leave confidential material unattended.
• Designate a person to review all press releases, speeches, corporate information such as brochures, financial statements, etc. to prevent inadvertent dissemination. Also calendar a periodic review of all these procedures to make necessary adjustments.

Trade secrets protection also must uniformly extend beyond your controlled environment. This includes your consultants working with your proprietary information. Even when dealing with third parties, it is useful to make sure that they have instituted the security program with respect to their employees. Another useful tool is the non-disclosure agreement (NDA). I suggest that you have a standard NDA for use with employees as well as outside consultants. This type of agreement sets out the manner in which the information is to be protected, the fact that you expect the information to be protected even beyond the time when the other person has stopped working with your company. It also can serve as a basis to assure you that the outsider will not subsequently compete with you by altering your trade secrets and passing them off as their own.

In a subsequent article, I will cover some of the legal rights you may assert when an employee or third party misappropriates your properly protected trade secrets. However, you have a number of tools that you can immediately utilize to start protecting your trade secrets. Remember if the asset enhances your company’s competitive edge do not risk loosing your advantage by simply asking that employee or outside consultant “Can you keep a secret?” …at least that this lawyer thinks.

Financing The Start-Up

Reprinted From January, 2000 Valley Business Journal
© Alan M. Insul, all rights reserved

FINANCING THE START-UP

So you say you’ve got the next “.com” that’s bigger than Amazon, Yahoo, and E-Toys combined. You think between time invested, lost earnings, and cash spent (borrowed at 18% credit card rates!) you’ve sunk a million dollars into the enterprise. You have even tied up the domain name and all its variations twelve ways to Sunday – “giagantic_huge.com”. So with all the capital chasing college kids and their internet start-ups, you should be swimming in millions – right? So how come you’re the only start-up in the world still not funded?

Finding the right investor, whether angel or venture capitalist, requires an understanding of the investor mind set. First, they are not risk takers in the sense of gambling or even entrepreneurs taking the same evangelical leap of faith you have shown for gigantic_huge.com. Second, investors look at hundreds or even thousands of deals. It is difficult to stand out from the crowd unless your business plan or executive summary identifies that this is the kind of investment they like. Third, entrepreneurs make the fatal mistake of assuming the venture capitalist wants to run the company, and that they always ask too much for their capital. Investors run, not walk, when they see such an inflexible attitude.

When all is said and done, internet funding has truncated the time associated with money raising, but it has not eliminated the basics. Your plan must show that gigantic_huge.com is selling a unique product or service, or uniquely delivering it. The market potential must be large enough to generate the kinds of returns sought by early stage risk capital. There is a management team that can deliver it. Finally, show the exist strategy for the investor.

Most entrepreneurs fail to recognize that investors in start-up or early stage companies are really risk adverse and seek to hedge or minimize those risks. They look for a product or service likely to capture a large enough share of an identifiable market so as to demonstrate a pay day with sufficient return. Early stage investors, such as angels (i.e. wealthy individuals), loose about a third of the time. Therefore, they look for returns sufficient to make up for their loses.

Some of the things they look for include shorter than their normal investment periods (5 to 7 years). Show some established revenue numbers whether directly from operations or extrapolated from an industry standard. This helps assess the potential market value of gigantic_huge.com. How quickly do you use capital (the “burn rate”). The higher the burn rate, the more you will have to demonstrate where gigantic_huge.com will get the next stage of funding – other than the investor. Can management pull this thing off. This is where the entrepreneurial leap of faith comes in. Muster that enthusiasm so it rubs off on the investor. Do not hide the holes in the management. Gigantic_huge.com is a start-up or early stage
company. Investors understand you are not top heavy in operational management such as financial or fulfillment. Venture capitalists are often your best source of added support to either hire the talent or supplement existing personnel.

Above all else, remember this is not a transaction where the investor deposits the money and you never hear from them again. It is truly a partnership in the sense that you should look to the investor for support. In turn, they look to you to provide honest insight as to your progress in achieving the business plan. For example, if the investor perceives that you consider them a nuisance, or that you do not understand why reasonable financial controls are legitimate, they will invest elsewhere – no matter how gigantic or huge gigantic_huge.com could become … at least that’s what this lawyer thinks.

Law in the Third Millennium… A Brave New World?

Reprinted From December, 1999 Valley Business Journal
© Alan M. Insul, all rights reserved

LAW IN THE THIRD MILLENIUM … A BRAVE NEW WORLD?

My last column of the year also just happens to be the end of the second millenium. I can’t pass up the chance to look at what my future grandchild (plus 40 or 50 generations) might say in their December’ 2999 VBJ column. Of course, with the retirement of the last lawyer sometime around 2355, the new breed of professional will focus on dispute resolution not the art of advocacy. Therefore, my distant heir to this column will proudly bear an ADR (alternative dispute resolver) instead of ESQ at the end of the Insul name…

“I happened to be looking at an old family memory disk from the beginning of this millenium. My very distant great grandfather who first wrote this column over 1,000 years ago started a tradition of
occasionally looking at the big legal picture. So I have culled through the entire third millenium’s archives and have summarized what I think were the most significant legal decisions:

* 2120 AD. In a landmark ruling with far reaching international and national implications, the Supreme Court has abolished all notions of privacy as a fundamental right under our constitution. The Court ruled that the framers of the Constitution did not contemplate a global economy much less the available arsenal of technologies which range from the passively ubiquitous record keeping of the WEB to the recent deployment by foreign corporations of SECOTO (Satellite Enabled Camera Observation Through Objects). In an obvious concession to territorial limits, the Court signaled that henceforth it would limit judicial review to alleged misuses of information gathered by the non-stop monitoring of every person from cradle to grave. In a footnote, the Court further reasoned that since technology renders proof of wrongdoing 100% certain, people no longer need the protections of the now arcane 4th amendment concepts of search and seizure.

* 2275 AD. Today the Supreme Court determined that all ‘Clark’s People’ (named after Barney Clark the first mechanical heart transplantee 300 years ago) are indeed entitled to protection as a ‘person’ within the meaning of the constitution. This ruling even extends to those having replaced their organic brain with ANIC (Artificial Neuro Intelligent Computing) which is programmed to mimic the former organic brain.

* 2532 AD. Bowing to long established scientific fact, the Supreme Court belatedly abolished all notions of causality in law. The Court felt compelled to reach this conclusion after the defendant’s ADR dispassionately pointed out that over 500 years ago Superstring or M theory Physicists disproved that time or space really exist. Chief Justice Juanita Gonzales wrote for the majority that ‘… the law can no longer abide holding a person accountable for their actions merely because a dozen witnesses subject to time and space illusions testified to seeing the defendant gang member hit the senior citizen with the baseball bat.’

* 2776 AD. On the eve of the millennial celebration of the old US Constitution (now the ruling document of all the world’s people), social and political disaster has been averted when the World Court in a 151 to 149 vote upheld the constitutionality of the Revised Social Security System. The Court affirmed the current system’s requirement that 10% of the non-voting equity of the world’s businesses be held in government trust to fund all worker’s retirement. In turn, workers are paid out of the equity hedge fund at 100 years of age or retirement which ever happens last. Wildly popular when first introduced, it has come under increasing attack from multi-nationals as an unfair tax upon their right to conduct business and the individual’s right to freely invest their earnings.

* 2993 AD. In a unanimous vote with far reaching implications for the rights of all living creatures, it has been agreed by all the people of the world that visitors to a past time must pledge not to disturb or interrupt the natural flow of events. It has come to our collective attention that for added recreation some persons visiting the last millenium caused our less enlightened ancestors great individual trauma and social ridicule by falsely leading them to believe that they have been visited by vastly superior ascension beings from that time.”

…We are indeed privileged members of our species. In a few days we will simultaneously stand on the peak of one millennial mountain and glimpse up from the nearly incomprehensible base of the next. Speaking for myself, I am not sure if I really would like or understand the world of mankind at the peak of the third millenium. But than again, perhaps King John had similar thoughts at Runnymede that day in 1215 AD while signing the Magna Carta. Thankfully, he still signed, and, metaphorically speaking, so should we…At least that’s what this lawyer thinks