One of the Easiest Ways to Increase Your Company’s Value Now: Review and Improve Your Company’s Third-Party Contracts

Most businesses have a lease, an IT-services agreement with a telephone or ISP vendor, off-the-shelf software licenses, and other relatively “non-negotiable” vendor and supplier contracts. It may not be that critical or even possible that those agreements be changed. But most companies also have standard “form” supplier, vendor, customer and other third-party agreements that should be reviewed and updated. Why? Because any future investor in or buyer of the business will review them in their due diligence of the company and will consider them in their valuation of the company. Third party contracts are often considered boring “boilerplate” and not significant. But getting them right can be one of the easiest ways to de-risk the business in the eyes of an investor or buyer. As a result, the investor or buyer will likely put a higher valuation multiple on the company.

1. “Standard” and “Bet-the-Company” Contracts. Depending on the company’s industry, contracts with suppliers, vendors and customers can be based on “standard” forms (invoices, general terms or more detailed agreements), counterparty-required forms (leases, off-the-shelf software and ISP contracts), and more tailored, negotiated agreements with significant suppliers, customers or other third parties. If the company’s business is regulated by a federal or other agency, the terms become more important to comply with applicable laws. Some bet-the-company contracts may have been negotiated with larger suppliers or customers and contain special provisions reflecting the significance of the relationship. Over the years, many businesses have moved the preparation, review and management of third-party contracts in-house or to contract management software providers. This is especially true for software-as-a-service (“SAAs”) businesses. Regardless, many company contracts may be legally outdated or not favorable from a business perspective in the eyes of an investor or buyer. So, one of the first steps in increasing a business’ valuation multiple and value is to review the company’s third party contracts and consider ways to change their terms to the company’s benefit and enhance their perceived value. It’s too simple and important to ignore, as mitigating perceived risk is one of the fastest ways to increase a company’s valuation multiple

2. Industry-Specific Factors and “Hot Issue” Terms. A company’s business model may bring it under the regulatory oversight of one or more regulatory agencies. In the “Innovation Economy”, even traditional businesses have become “technology” and “international” businesses, and many of their business models have become subject to antitrust, data privacy and security, export and import and other laws regulating third-party dealings, supply chain management, outsourcing and other evolving business model attributes. Any review of a company’s third-party contracts must be done in the context of the company’s industry, whether it’s a consumer products provider, government contractor, energy-related business, medical or biotech business, or B2B manufacturer or distributor, or it serves another market. Most businesses are subject to labor and employment and tax laws, and many are subject to laws related to consumer protection and safety, the environment, chemicals, energy, intellectual property, data protection, and international trade. Compliance with applicable laws is critical to a company’s risk mitigation, and third-party contract terms can be equally critical to that compliance. And, of course, third-party contract terms can be critical to protecting the company’s trade secrets and other intellectual property. Many new business models involve third-party relationships that bring unforeseen laws and regulations to bear. And certain “hot issue” terms will get the attention of investors or buyers. These include non-competition and non-disclosure covenants, exclusive dealing arrangements and indemnification and other provisions that either restrict the company’s future business dealings or expose it to potential third-party liability.

3. Why a Company Contracts Review Matters. Even if a business has operated well with its current third-party contract forms, future company investors or buyers will definitely do a “deep dive” into their legal and business details and potential issues. Those details may either relate to legal compliance issues or to contract terms that are unfavorable to the business. These terms might include the term and termination, the parties’ respective payment and other obligations, exclusive dealing, noncompete, confidentiality and other covenants, indemnification and even legal remedies (including boring or “boilerplate” terms relating to governing law, legal fees and where litigation can be commenced). To the extent a company can change or re-negotiate any unfavorable third-party contracts prior to raising capital or selling the business, substantial additional value may be realized. Mitigating a business’ perceived risks is the fastest and easiest way to improve its valuation multiple, and vendor, customer and other third-party relationships and contracts are a critical area of mitigating risk and improving the company’s perceived value.

4. How to Assess a Company’s Contracts. Seller “self” or “reverse” due diligence should include a review of its standard and more significant third-party contracts. This review might be done by in-house counsel, outside counsel, or other industry professional advisors. The review will not only identify risk factors that will certainly be considered by an investor or buyer, but it may reveal opportunities to re-negotiate existing contracts and improve contract forms going forward. This is about both business (customer “stickiness”, renewals, cost containment, and pricing) and legal issues, both of which should lead to company value enhancement.

5. A Side Note on Software and Technology Services Contracts. Some business models rely entirely on software licensing or technology services, and many traditional businesses have supplemented their core business with software and technology services, or even outsourced research and development, supply, sales, distribution and manufacturing management services. These services often involve contracts governing the licensing and ownership of software and other intellectual property, technical specifications, maintenance and service-level and other obligations, not to mention liability limitations, indemnification and obligations around data privacy and security. Suffice it to say that, whether software licensing or technology services are a company’s core business or an add-on product or solution, special attention needs to be paid to these contracts to mitigate company risk and protect company intellectual property.

Take-Away: Don’t Take Your “Old” Contracts for Granted

A large portion of any investor’s or buyer’s due diligence of any company will focus on vendor, supplier, customer and other third-party contracts, including leases, licenses, and any contracts containing restrictive covenants, exclusive dealing and extraordinary obligations or liability exposure. Reviewing all of these contracts, anticipating investor or buyer concerns, and considering changes to improve their terms will go a long way to mitigating a company’s perceived business and legal risk and enhancing its valuation multiple and ultimate valuation in a capital raise or sale.

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