Archive for February, 2010

Making SaaS out of a Services Agreement

February 20th, 2010

Many software companies build products that live on the web and don’t install on local computers at all.  Enterprise-focused companies call this SaaS; everyone else just calls them web-based or hosted services.

Either way, developers of these products sometimes look for customers among big companies.  It is really common then that the customer’s contracts manager doesn’t quite get the nuances and sends over some kind of Master Services Agreement to document the deal.  Those agreements are generally based on the idea that the vendor is providing a specific, custom deliverable and don’t fit the situation very well.  I have been through this drill a lot and have a few observations about some of the important differences between a custom services and a SaaS deal.

1)  Work for hire language.  A Master Services Agreement will almost always say that the customer owns all technology and works created by the SaaS vendor during the course of performance.  This would be true if the vendor was writing custom software, but is the opposite of what the vendor wants in a SaaS situation.  This should be replaced with something that says the vendor owns all the software and anything developed during the term of the contract, and that the customer has a license to use all of it (subject to payment of all fees).

2)  Service levels.  The Master Services Agreement may not have any service level terms, such as an uptime guarantee or detailed procedures for responding to service errors.  This can work out well for the vendor since it allows more flexibility and avoids difficult conversations about discounts if the service goes down.

3)  Source code escrow.  Some companies feel strongly that if an important vendor goes out of business they should be able to take over the source code to preserve continuity.  With SaaS products these terms are especially inappropriate because the service is hosted- a customer would have to take over the entire service rather than just getting the source code to maintain an installation at its own facility.

4) On-site services.  Master Services Agreements can use a lot of ink on issues like vendor behavior on the customer’s premises and the customer’s ability to replace vendor personnel.  This comes out of the idea that vendor personnel will be in the customer’s data center regularly, which is not correct in a SaaS relationship.  I watch out for language that is really egregious here, but mostly try to leave this stuff alone since it just doesn’t apply very often.

The point of this post is that a Master Services Agreement is the wrong tool for the job in a SaaS deal.  From the vendor’s side, some terms definitely need to be changed, while others are not applicable but can be left mostly alone.  I always try to make the minimum set of changes that will let everyone sign the deal and get the relationship underway, while making sure there is nothing in the agreement that can come back to bite my clients later.

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IP Law for Startups Blog on Bratz vs. Barbie IP Dispute

February 15th, 2010

I recently started reading Jill Hubbard Bowman’s excellent IP Law for Startups blog.  I don’t practice IP law, but a lot of the work I do touches on intellectual property issues so I find her posts helpful and illuminating.

The “moonlighting” problem is pernicious for startup entrepreneurs.  It can take months or years to nurture an idea to the point where it can pay a salary, so it is natural for many people to chip away at their plans while earning a paycheck somewhere else.  The problem is that if their idea is closely related to their day job activities, and if they are not extraordinarily careful to avoid using work resources for the side project, then their employer can claim ownership of the new business ideas.

Jill has a great example up on her blog based on the Bratz dolls.  You should click through to read the whole thing (and subscribe to the blog), but some key facts include:

* $1 billion in claimed damages

* $100 million in legal fees for defendants MGA Entertainment, Inc. and Carter Bryant.

Ouch.

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6 Important Terms in Your Website Terms of Use

February 10th, 2010

Website Terms of Use are challenging for many entrepreneurs.  Many new companies have limited cash resources so deciding to pay a lawyer for a set of TOU can be a hard decision, especially with so many free examplars out on the web.  You should definitely review existing TOU prepared by other companies in your space.  At the same time, details matter a lot.  A company in your sector may have a different set of features that makes its TOU mostly, but not quite applicable to your exact circumstances.  I can’t tell you exactly what should go in your terms or whether you always need to pay a lawyer to prepare them, but here are some key terms to think about when you review the TOU landscape in your field.

Pricing
This is a fairly obvious one, but will your site’s model be free, freemium or full-fare to users?  Will there be a trial period?  You would get extremely different pictures of what is standard for a news website depending on whether you used WSJ.com or NYTimes.com as a model.

Use and Content Licensing
This point is critical.  Will your users principally browse content on your site?  Will they use it to filter content from other sites?  Will they post a lot of original content? Reblogged content?  Will their information all be publicly available or will users maintain private information?  There are a lot of variables here and good terms of use will tailor themselves to your site’s particular needs.

For example, if your site is social like Flickr, your terms will reflect a higher degree of concern for ownership rights and you will want your users to affirm that they own or have rights to the content they post in very clear terms.  You also want unequivocal rights to display posted content publicly.

At the other end of the spectrum is a site like Mint, where users import private information on their banking and financial records.  You would want your users to grant you a license to incorporate their financial information within their accounts, but you would probably not want a lot of language about public display lest you cause confusion about what information you can/will make public.

Social Networking
Will your users interact on the site?  If so terms regarding a code of conduct are warranted.  Nearly all new web businesses I talk to these days envision some kinds of user interaction, so this is pretty close to “boilerplate” but I beef it up or trim it down depending on the site’s exact model.

Third Parties
If your site relies on advertising, sponsorship or other types of promotional content from third parties you need to explain to users what types of interaction to expect, what types of user information you can give to third parties and when you can/will give it.  This is a touchy area since sites need to develop partnerships and mine value from their user bases, but users are very wary of being spammed.  There is a delicate balance to be found depending on a site’s model.

Governing Law/Disputes
This one varies a bit less from site to site.  The important thing to know is that website TOU are enforceable in court, but fairness is a strong consideration.  If your TOU require users to come to a specific location to bring action against you, be aware that a court may well decide to throw out the term if the value users get is low.  Having a bunch of onerous provisions in your TOU may well lead a judge to look unfavorably on the whole thing as well.  There hasn’t been that much litigation over TOU in the last 15 years so it is hard to draw strict rules here, but the rule of thumb is to be reasonable.

Notice of Changes
The last important point is- what happens when you need to change your terms?  Most TOU say that changes are effective when posted to the site, and there is also case law saying that it is not reasonable to require users to check up on the current TOU continually.  Opinions vary widely on how to manage this, but my own view is that (i) non-material changes are ok to simply post, but (ii) if you need to add significant provisions or change material terms, you should let your users know by email as well.  That is why my practice with TOU is to tailor terms as carefully as possible to a client’s needs, and also leave room for the model to evolve so that we don’t need to revisit the TOU frequently and/or send out notices to users except in rare situations.

This is a complex topic and I have certainly not tried to be comprehensive.  Proper treatment of this subject would also include key terms in a Privacy Policy, since privacy policies and TOU go hand in hand.  This post is long enough already, though.  I will come back to privacy another day.

 

 

 

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How to Allocate Shares in a Startup When One Founder is Also an Investor

February 5th, 2010

I frequently talk to entrepreneurs starting a company where one founder is putting up seed capital while the others are putting in sweat equity alone.  The founders want to divide the company ownership according to some formula they have figured out, and then ask me how to document it properly.  This are several variables required to do this correctly.  Here is how I think about it:

Percentage Ownership
The founders have figured out an ownership ratio that makes sense to them.  Let’s say there are 3 co-founders, all of whom will be active day-to-day.  One founder will invest $100,000 in seed capital and the others will invest only nominal cash.  The founders have agreed that each of them should get 33.33% of the initial shares.  For simplicity let’s say that each founder gets 1,000,000 shares.

Stock Price
We always want to keep the price of common stock low so that as new employees, co-founders or others come along they can buy stock (or get stock options) at a low price.  I usually like to start with a founder stock price of $0.001 per share.  Stock should always be bought for cash, so we immediately have a problem matching the 1/3-1/3-1/3 ownership ratio with the varying amounts of cash being invested.

Using our hypothetical numbers, Founders A and B are getting 1,000,000 shares at $0.001 per share, which means they need to put in $1,000 each.  If Founder C is buying the same type of stock, also at $0.001, his $100,000 will buy him 100,000,000 shares; he will own 99.99% of the company.

Preferred Stock to the Rescue
My recommendation here is to treat Founder C an investor as well as a sweat equity founder.  By this I mean that we can issue some of his shares as common stock like the other founders, and some of it as preferred stock, which lets us set a higher per share stock price.

Preferred stock is “worth” more because it has rights preferential to common stock.  The rights can vary a lot, and in this case I would provide only a nominal step-up in rights compared to the common stock, so that if our company gets sold Founder C would get his money back before any money is distributed among the common stock holders.  If the company is sold in an extreme fire sale, it is possible that Founder C would be the only one to get any money out, but with luck we will be able to sell this company for more than $100,000.

Stock Repurchase Right
The last important piece here is that all founders should have their sweat equity shares subject to a company repurchase right.  The stock “vests” so that if a founder leaves after a year or two, she only gets to keep the equity she has earned through service.  In my view, all of the common stock should be subject to the repurchase right, but since the preferred stock is purchased for a cash investment, it should not have a repurchase right attached.

In this example, 100% of Founder A and B’s shares are subject to repurchase, but 90% of Founder C’s are not.  This might be the right outcome- or we could adjust the Preferred Stock price and the relative amounts invested for common stock and preferred stock so that Founder C owns more common stock, and has more stock subject to repurchase.  There are a no “right” answers here and it is just a matter of finding the set of conditions that best represents the founders’ relationships.

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