Navigating early contracts with large commercial customers

Your early contracts with major customers can determine whether your climate startup thrives or fails. Landing a key account can open doors to other customers and investors. Their resources may help you unlock manufacturing, or give access to a massive downstream market. A strategic customer may end up being a major investor or future acquirer.

When the stakes are this high, how can you negotiate terms that serve both your business’s immediate needs and future growth? With some thoughtful planning, you can ensure you are well positioned to move fast and create the foundation for a strong and successful relationship, while also protecting your ability to be flexible, build your customer base, and pivot if needed. 

Kevin Lee is the founder of Climate Tech Legal. We chatted with him to learn about the purposes these contracts serve, tips for ironing out the details, and how to get the most out of working with a lawyer.

The start of an evolving relationship

A common scenario for startups working with their first large customer is that there will be an initial getting-to-know-you phase and/or proof-of-concept activities before getting to more serious purchase commitments. As a startup, your goal will often be to announce a deal as soon as possible, and this may take priority over working out the details. Thus, a common approach is to enter into a non-binding letter of intent to describe the intentions of each party and the desired goals of the relationship, all of which can be framed at a fairly high level. With an executed LOI, you may be able to make a joint public announcement, promote the relationship in your other business development activities, and show momentum to investors. 

Beyond the LOI phase, you should think carefully about what a successful relationship looks like to you over time. A useful framework is to think of each relationship in phases. What activities are meant to occur in each phase, what are each party’s roles and responsibilities, and what are the deliverables or metrics that determine success? Those outputs will usually make up the conditions for moving forward to the next phase of the relationship. For example, a typical sequencing might look like this:

• Phase 1: share materials, desired specifications, and do initial testing for suitability. 
• Phase 2: produce a small batch of customized products to meet customer needs, and go through third party testing. 
• Phase 3: initial commercial orders worth $50,000. 
• Phase 4: formal commercial orders worth $1,000,000 over 3 years. 

Each phase increases the confidence of both parties and allows continued development, and should also provide a clear off-ramp if goals are not met and the parties must end the relationship. This structure also allows you to invest more time in clarifying the details around the activities in the first phase(s) over the next 6-12 months (e.g., meeting specific performance criteria), without overinvesting in the specifics of the later phases that you are not ready for (e.g. exact timing of payments, when risk of loss transfers when delivering products). 

With your internal goals in mind, you can begin negotiations with your customer. Including the full roadmap of phases may be helpful to align both parties, and having clear success metrics will help push your customer forward to future phases. However, sometimes it will be easier to take one step at a time and defer discussion of long-term goals. The bulk of your efforts should be on fleshing out the details of the first phases - who will do what and what payments will be made. In the above example, it’s possible for Phases 1 and 2 to require minimal legal documentation because neither party is making expensive or long-term commitments. 

Know your power to negotiate & navigate the customer organization

Just because the customer is a Fortune 100 corporate with a large and unwieldy bureaucracy, it doesn’t mean you have to accept their terms without pushing back. You have a lot of power to shape these contracts, but you also need to be able to navigate the systems and know where you can and can’t push. 

First, you should build an internal position on what you want the relationship to look like and what your priorities are, so that you have a framework from which you can negotiate any particular terms. 

After you get past initial business discussions, you will usually be asked to use your counterparty’s paper - such as a master service agreement. Note that while their documentation might not be the most suitable for your business model, it’s likely faster to work within their system than to try and get them to agree to your own bespoke agreement. One surprisingly common error is the counterparty will provide a form agreement that is not suitable at all to the type of relationship you’re building (e.g. they provide a construction agreement when you’re selling a SaaS service). Be sure to educate your counterparty and their supporting teams so you start from the right place, and you may be able to eliminate needless cycles. 

Be sure to tap into the resources available to help you understand what the sales process will look like: your champion on the customer side may be able to help you know where and when various teams such as procurement, risk management, and legal come into play, and investors or advisors with industry experience may also be able to help set expectations.

By having a strategic approach and understanding of the landscape, you will be better positioned to negotiate key terms with the right parties. For example, you want your business counterparties to buy in to all the key material terms, as they are the ones who might have to push the legal team to accept non-standard terms. If the customer’s legal team gets activated too early and takes over negotiations, you may become mired in technical details and spend significant time and dollars for little value. 

The different functions of your contract

As you work through a contract, keep in mind that the documentation will serve several different functions.

1. Laying out your obligations
At its most basic, the contract defines the rights and obligations of each party. This covers the goods or services that you’ll be providing and what you’ll receive in return; your legally-binding obligations to the customer, such as price, delivery deadlines, warranty/support obligations; as well as the customer’s obligations, such as payment, and other obligations or activities they must perform. It may also contain specific restrictions, such as exclusivity, rights of first refusal, or options. Finally, there will be legal terms around confidentiality, intellectual property rights, and dispute resolution. 

Note one common point of confusion is that contracts are not primarily designed to describe what the intended successful relationship looks like, or what the parties hope to achieve. Sometimes you can include language in the contract to help set expectations, but you should clearly distinguish what the parties hope to occur - not necessary in a contract - from what each party must do or has the right to do. 

2. Risk mitigation
The contract also helps protect your business by clearly defining parties’ responsibilities, especially in areas where they may be unclear or that may lead to disputes, and outlining what happens if things go wrong. 

Your corporate partner will usually impose insurance requirements so they know that funds will be available in case you cause damage or harm, or if property gets destroyed. For climate tech companies and others operating in the real world, spend time planning your insurance coverage needs based on the industry you’re  in and what customers typically require. While some customization for each customer is possible, setting up or making changes to your insurance program can be slow and challenging, so work with a good broker and have a plan in place.

3. Storytelling
While an LOI is often used for fundraising or marketing efforts, the contract itself is also often a milestone to use in press releases and public announcements. As you negotiate detailed terms, the more important storytelling function is to set the right expectations with your counterparty. 

One mistake that I often see made is that in the rush to close a deal, a startup will accept certain terms that they plan to change later when they get to a larger agreement. But when it’s time for that larger agreement, there is very little appetite to re-open negotiations on terms that were agreed to previously. Thus, use careful judgment when agreeing to terms that are not critical for the short term but would become longer-term issues. Perhaps it’s worth spending time to get those right in the first place, or perhaps there are ways to defer taking a position on those thorny issues until a later phase in the relationship. 

Common terms to watch out for

1. Exclusivity
As a startup, your future is uncertain, with market conditions, your business model, and your technology all subject to change, so you generally want to maintain flexibility as much as possible. 

If your first project truly represents the best opportunity you could hope for and it comes with a huge committed revenue amount, it might be worth bending over backwards to give the customer more of what they want, including some type of exclusivity or rights of first refusal. Even then, think carefully about the scope of exclusivity - can it apply only to a certain industry, or to certain players within the ecosystem, or certain territories? Pay attention to duration, and make sure any exclusivity is paired with commensurate commitments and value from the other side. Are they willing to grant mutual exclusivity? 

With creative thinking, you can strengthen a relationship that accelerates your ability to reach your goals. But if done poorly, you may lock yourself out of vast swathes of your target market, or end up with long-term obligations that are no longer worth the cost. If you aren’t certain, consult with your Board members to see whether they agree with the tradeoffs you’re considering.

2. Term & termination rights
The duration of the relationship, rights to terminate, and what happens upon termination are always important in a contract. For example, you might be excited about a ten year contract, but if the customer can terminate upon 30 days notice for any reason and you can’t, then you are in a very different position than one where both parties are committed, or where both parties can terminate. 

Always evaluate the termination provisions from the perspective of what happens if you want to exit but the other party doesn’t, and vice versa. Think substantively about the risks and ways that things can go wrong, and make sure the contract adequately addresses each scenario. 

In some cases, mutual termination for convenience can be a shortcut to avoid significant negotiations over challenging terms. The lack of a long-term commitment has obvious downsides, but can make sense early on in a relationship when neither party is making significant investments and the goal is to get to a deal quickly. 

3. Milestones and external conditions
For innovative products and services, you might have to jump through a lot of hoops in terms of certifications and third-party testing to meet a large corporate customer’s needs. Be mindful of how and when this will occur.

In general, be aware of when third party activity will be required for your relationship to succeed, and take that uncertainty into account. While it’s natural to think about what happens if one party doesn’t perform, it’s more complicated to address situations where a third party fails to perform or if an external condition is not met.  

4. Technical requirements: data security, policies, etc.
A large customer may be accustomed to imposing certain policies and practices on its suppliers and vendors, but startups may not yet have the infrastructure to meet those needs. A common area of concern is around data security and privacy. If you are a SaaS company or hold significant personal information or sensitive data of customers, you will need to develop an approach on data security and privacy compliance early on. You should aim to meet industry standard requirements, and understand your privacy obligations. 

Similarly, customers may impose additional compliance requirements in terms of safety or employment practices, non-discrimination, anti-bribery/anti-corruption, export compliance, and more. You should consider evaluating whether your business model or industry is especially sensitive to those issues so you can develop an approach. If there is very low actual risk but very high compliance requirements, you may need to discuss with your customer how best to navigate their systems so that you don’t misrepresent your capabilities but also move forward in a way the customer can accept. 

5. IP
Protection of your intellectual property is important for all companies, though companies with deep technology and innovations will want a more strategic IP approach. In a commercial deal, it’s important to clarify ownership of IP that is developed in the course of the relationship. In many cases, the IP that is central to your business is clearly distinct from your customer’s IP, and in such cases it’s fairly straightforward to allocate ownership of IP. However, if your core IP overlaps with your partner, then you’ll need a more nuanced discussion on ownership and especially the results of any joint work between the parties.  

Tactics for negotiating successfully

1. Know what your goals are
Before you start negotiating, flesh out what your actual goals are with this project. It won’t always just be selling X quantity of goods at Y price – it might be establishing a stepping stone to a much larger deal down the line, either with this customer or a future customer. Understanding up front the value you want to capture will keep you on track and help you make compromises on your own terms, rather than being pushed in the direction your customer wants you to go. 

2. Be clear and transparent
Putting all of your cards on the table is generally a better approach than playing mind games. Be open with the customer about what your goal is – maybe it’s doing $10m in revenue with them in three years time – then ask directly what the contract needs to look like to get you there. Aligning with your customer will set a strong foundation and avoid surprises down the line. 

3. Define edge cases to reduce risk
Just because your customer is paying and you're doing the work doesn't mean they don't also have responsibilities. If their obligations aren't clearly defined while yours are, you can be held accountable if deliverables fail because they didn't meet their commitments. Spend time with your team to list everything that could go wrong, then structure the contract to protect yourself – whether by reassigning the risk, reducing your exposure, or accepting certain risks with your eyes open.

4. Know your counterparty
If your point of contact has no decision-making power or budget, you could waste a year trying to sell to them without success. But as well as finding the right person, you need to know what incentivizes them and their position within the company’s internal dynamics. Spend time with this stakeholder, asking them questions like ‘What can I do throughout this process to help you sell this internally? Who do you need to get buy-in from? What are you measured on? How does this project align with your company’s stated strategic goals?’ 

5. Use your lawyer well
Lawyers are typically focused on making sure the contract says what you expect it to say, and then watching out for downside risk. It’s worth taking some time to ensure your counsel understands the general nature of your business, what you want to accomplish with this deal, and what risks you see occurring. 

Contracts also often have significant language about operational activities or other terms that are up to business teams to review. Your attorney can be helpful but ultimately you may need to review and comment on whether you can meet those obligations. 

A good commercial lawyer will be a business partner and be able to help you achieve your goals while pointing out and mitigating risks, but it does require a cooperative effort to get on the same page regarding urgency, risk tolerance, and key terms. 

Kevin Lee is the founding attorney at Climate Tech Legal, where he provides commercial & corporate legal support to climate tech companies, from founding through Series B and beyond. With over 10 years leading the business legal teams at disruptive clean technology companies (EVgo, Bird), Kevin has been on the ground helping companies build new business models, partner with strategic partners, raise equity & debt, navigate regulatory hurdles, engage in major corporate transactions, and manage day-to-day legal needs. Kevin received his J.D. cum laude from Harvard Law School and his B.A. summa cum laude from Yale University.