By Erik Ott
In Part 2 of the Brand Market Expansion Series, we considered initial engagement with prospective partners and provided a roadmap for making an informed decision. In Part 3 we look at negotiations of key commercial terms to ensure a successful long-term partnership. (Note: an attorney should be consulted about legal issues such as the scope of what is being licensed, intellectual property rights, warranties and indemnities, etc.).
The work done during the initial partnership engagement should have created rapport between the parties and established a solid baseline for communications. It is quite likely that you have determined which prospect is the right fit, or perhaps you’ve narrowed the field down to a short list of candidates. Before paying lawyers to negotiate an IP Licensing Agreement, it’s good practice to put together a term sheet to help both parties finalize the commercial terms. Given that the parties have already developed a joint go-to-market plan, it should be pretty straight-forward to put together a win-win deal. The key term sheet areas to focus on are:
Sales and Marketing Commitment: The success of any market entry is directly correlated with the level of commitment to sales and marketing. On the sales front, the brand must commit resources to the partnership. This can take the form of “feet-on-the-street” sales resources or funds for a partner (likely another brand) that will handle sales. The level of the sales commitment is likely to be the single most important success factor in the partnership, and will therefore have the greatest impact on the negotiation of the royalty rate. Assuming a brand hires a sales representative exclusive to their brand, this will likely be a commitment that approaches six figures annually. Using the simplest math for illustrative purposes, a brand receiving a 10% royalty would need to generate $1m in sales to break even on their salesperson alone. If resources are shared and the commitment is to pay for a percentage of the partner’s team out of royalty proceeds, then the brands resource commitment will be reduced, justifying a lower royalty rate.
The second input to consider is marketing. Both retail training and budtender education continue to be drivers of brand adoption. Developing and investing in a retail engagement strategy that conveys the brand’s authenticity and consumer value proposition (product/market fit!) will certainly be an important factor in the success. The key is for both sides to understand exactly what the marketing strategy is and who is funding it. Many marketing strategies are “in-kind,” and others require firm cash commitments. At the end of the day, the partners need to determine what will be needed and how those requirements are to be funded. All of this will plug into the business plan developed in Part 2 to project how the partnership makes money and how that revenue is shared.
In summary, the dollar commitments to sales and marketing by the brand are not only the single greatest success factors but also key determinants in the negotiation of the royalty fee. Both parties must look at the projections together, develop a clear understanding for how much each party can expect to earn, and have an informed discussion about profit sharing. The industry standard royalty range is between 5%-15%, and the best way to land on the actual number is through a joint evaluation of the P&L created by the parties. What comes out of those discussions are a number of deal points that are directly related to honoring those commitments.
Exclusivity and performance obligations: Both parties are making a sizable investment in the partnership’s success and are now putting those commitments on paper in the form of an IP Licensing Agreement. One important discussion point regards exclusivity. In the majority of instances, brands will pick a single partner to execute their market entry strategy and grant that partner exclusivity. However, sometimes the brand wants the partner to focus exclusively on that brand’s format and agree not to take on any directly competitive brand. Or perhaps the brand wants the partner to achieve certain “guaranteed minimums” to maintain future exclusivity. There are a few strategies brands can utilize in these negotiations. One that is particularly useful is “time-based” exclusivity. If a brand launches a format and forecasts are being achieve, there is little incentive for a partner to pivot to another brand with the same format. A period of time is needed during which the parties can work through any kinks related to a less than desired market reception. Sometimes those fixes take time, and sometimes there are no fixes. Structuring a relationship that contemplates the need for both parties to be exclusively focused on the success of the partnership for a period of time is a reasonable ask. If things are going well, it’s easy for a partner to maintain format exclusivity, but if after, say, six or nine months, results aren’t tracking, an exclusivity “out” may be justified. This is typically dealt with contractually in the term and termination section.
Term and Termination: Most IP licensing deals are structured with the knowledge that it takes time to build a brand in a market. Because a business plan has been developed, it is likely that year one expectations are realistic regarding brand penetration and market share capture. Year two should be where meaningful growth occurs, and most deals are structured with a minimum two-year term for this reason. A third year “option” may also be included and may be automatically triggered if certain performance benchmarks are achieved.
Contemplating what happens if things are going well, or poorly, is done in the term and termination sections and will typically include a “cure” phase where both parties have time to right wrongs. This section will also define “breach,” and while lawyers will ultimately provide the agreed upon language it is considered a best practice for the partners to discuss the conditions for termination. Having a time set aside in negotiations where the two parties sit down under the guise of “hope for the best, plan for the worst” will give both parties their first look into how the other party thinks and behaves when problems arise. Other key components of agreement termination will be termination due to breach, insolvency, or change of control. This last item is very much a “commercial” term since it sheds light on what the objectives of the parties are in entering into an IP Licensing Agreement. Most cannabis brands foresee a liquidity event at some point in their future, and the prospect of locking an eventual acquirer into multiple agreements across the US may not be favorable. This can cut both ways, so having a discussion around the conditions of agreement transferability will be worthwhile as it will shed light on the medium- to long-term objectives of the partner.
Many companies like to kick these issues to lawyers, but the truth is these discussions are helpful in truly getting to know how your prospective partner thinks and acts when the going gets tough – which it almost surely will. By tackling these issues with your partner, and working through them to the point of a signed term sheet, you will have created an environment where commitments on both sides are clear. Of course, negotiations will continue with regard to License Scope, Warranties, Indemnities, and other matters, but the relationship and transparency established through the commercial negotiations should serve to make the final details easy to resolve – and also save a lot of money in legal fees.
Unfortunately, not all relationships will be successful; on average, about one in three relationships fail. Failure results in lost investment, brand damage, and a high investment of management bandwidth. The roadmap defined in this 3-part series does not guarantee success, but it is designed to encourage an open, transparent relationship with attention to key details that many operators tend to skip over in a rush to get to market. The best practices for brand expansion invest time and energy on the front end to arrive at the most advantageous partnership alignment possible, thereby increasing the likelihood that the future will be dedicated to celebrating the deal rather than unwinding it.
