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Early Stage Companies and Strategic Business Alliances

Posted in Web/Tech

By: R. Todd Wilson

Early stage companies often hope to gain significant operational advantage by forming strategic alliances.#160 Such alliances may significantly accelerate the growth of such companies.#160 By collaborating to achieve mutual commercialization or implementation goals, the entities that form such alliances seek to maximize the value of each entity’s intellectual property in ways that, without such collaboration, would not be individually possible.

Key to the success of alliances is that they are designed not only to complete the transaction in which they are created but to ensure that the resulting relationship accomplishes the technology commercialization or implementation goals of the partners entering into the alliance.#160 If structured correctly, strategic alliances can reduce the time, cost and risk of launching new products. Additionally, alliances often allow a quicker means of developing new technologies and accessing new markets.#160 On the other hand, if the strategic alliance deal structure is flawed and expectations of the partners are not aligned, the relationship will falter and the expected advantages of the alliance will not likely be achieved.

Strategic alliances are arrangements between two or more entities to achieve certain goals.#160 Such alliances, in their simplest forms, may include license agreements, marketing agreements, and development agreements.#160 More complex alliances include equity investments, joint ventures, acquisitions and mergers.#160

In each business and technology alliance, there are often complex legal and business challenges. The need to identify, protect, procure, transfer, develop and/or commercialize intellectual property is one of the most important, but often the most difficult and contentious, aspects of alliance negotiations and implementation. Equally important is the need to identify and implement the appropriate structure for the business which is the subject of the alliance.

The simplest of strategic alliances include contractual arrangements between parties which are generally short-term arrangements with specified responsibilities and goals. Contractual-based alliances take many forms including those for intellectual licensing, product development, OEM agreements, product marketing and services arrangements. In such simple alliances, a formal management structure is often not required. The contract governing such an alliance, however, should include pertinent aspects of the relationship such as (1) confidentiality, (2) ownership of pre-existing intellectual property and intellectual property developed by the alliance, (3) scope of work and responsibilities of the parties, (4) milestones for development and/or commercialization of technology, (5) logistics and financial terms, and (6) term, termination, and assignment of interests.

Equity investments are another means of forming alliances between early stage companies and strategic commercial partners. A minority equity investment may be accompanied by a contractual agreement between parties such as a technology licensing, OEM, or distribution agreement. The commercial partner may wish to form this type of alliance in order to gain a competitive advantage through access to the early stage company’s technology and to take part in that company’s financial success through equity ownership. The early stage company may seek the validation of its technology and business model as well as access to capital that the commercial partner affords. The early stage company should consider carefully the potential loss of operational control and independence that such an alliance presents, however.#160 Additionally, regardless of the equity investment, any sudden change of direction by the commercial partner regarding contractual agreements between the parties could have a significant financial impact on the development stage company.

Joint ventures involve creating a separate legal entity such as a corporation, limited liability company or partnership through which the alliance partners conduct business. Joint ventures are typically created when a long-term alliance between partners and a separate management structure is intended. The parties to a joint venture might expect that the newly formed entity will, in time, be able to function entirely independently of the original parties. Joint ventures are created to combine complementary technologies and products, to develop or expand marketing and distribution expertise, to share technical or professional experts, to share economic risk, and to increase financial support or share economic risk. Considerations in forming a joint venture should include intellectual property rights of the joint venture as well as the forming parties, revenue sharing, governance and management, dispute resolution and exit strategies. Also to be considered are the commercialization-focused aspects of the alliance including product development, production, distribution and sales.

Mergers and acquisitions are a more permanent means of aligning two previously independent business entities. The parties to a merger or acquisition may agree to such a business combination to (1) acquire technology or to complement or replace a current technology, (2) to acquire complementary products to broaden an existing product line, (3) to acquire new or complementary markets and channels of distribution, and (4) to acquire resources and to benefit from the economies of scale that such additional resources afford. An early stage company may gain a considerable leg-up in its commercialization and marketing efforts by merging with a more formidable partner while an acquiring company may gain considerable technical and intellectual property resources which might not otherwise be available. Important considerations for both parties in conducting their due-diligence investigations relative to such a business combination include evaluation of intellectual property and technology assets, review of pertinent licenses and other contractual arrangements, and review of financial information.

Each form of strategic business alliance offers particular opportunities for early stage companies. The growth of early stage companies may be significantly accelerated through strategic alliances in each of the various forms. Additionally, even the relatively simple forms of alliances such as contractual and licensing arrangements can turn out to be the first step toward equity investments in or acquisition of the early stage company.

Early stage companies must also be aware, however, of the potential risks presented by strategic alliances. For example, early stage companies may lose considerable independence and operational control as a result of an alliance with a financially powerful partner. An early stage company also potentially loses its ability to control the confidentiality of proprietary information and trade secrets. Additionally, an early stage company often finds itself unable to take advantage of future business opportunities with other firms that compete with an alliance partner.

Finally, a host of other considerations face early stage companies with regard to strategic alliances. In addition to the business and intellectual property considerations involved in each type of collaboration between an early stage company and a potential partner, the parties must consider the competitive, logistical, tax, antitrust, and accounting issues surrounding each type of strategic business alliance. The parties must also determine the appropriate management style for the alliance and how to avoid potential culture clashes between the aligned parties.