Business Strategies / Power Lunch

Power Lunch: A Primer on Commercial Agreements

Be careful of long-term or exclusive commitments when just getting started.

By Jeremy Halpern of Nutter

briefcaseFood and beverage companies frequently turn to outside partners when launching their brands. These commercial arrangements are often an absolutely critical part of ensuring a brand’s success. However, they come with real risks and traps for the unwary.

Early-stage food and beverage companies often consist of only the founders and a few key employees. These kinds of teams often have gaps in their skills base. Founders might be primarily marketing and brand-type people. They may have little to no manufacturing or supply chain expertise, and they may have limited exposure to the sales and distribution end of the business. Partnering with outside companies, such as flavor houses, product development consultants, co-packers, co-manufacturers, brokers, sales management agencies, public relations firms, etc., allows these early-stage companies to preserve capital, increase domain expertise, increase their network and grow at a more rapid pace.

But these commercial agreements can present both near- and long-term risks. Entrepreneurs should avoid deals that solve problems for the short-term but which may inhibit or even prohibit future growth. For example, granting exclusivity to a co-packer on the East Coast with attractive pricing might be great today, but may lead to massive shipping costs when the company expands to the opposite coast.

In every case, these deals should support real growth in terms of creating sustainable gross margins for the product and repeatable sales into a broad customer base. Further, deals should always create alignment in the performance incentives so that both sides have the opportunity to win.

Entrepreneurs should pay extra careful attention to:

  • Grants of geographic or channel exclusivity to distributors or brokers.
  • Grants of exclusivity to manufacturers.
  • Production minimums and take-or-pay provisions in manufacturing agreements.
  • Termination fees to exit relationships.
  • Non-compete obligations.
  • Long-term obligations without the right to terminate for convenience or upon the poor performance of the partner.
  • Large cash retainer obligations for an untested partner.

Entrepreneurs should be thoughtful before entering into long-term manufacturing contracts. Early on, when brand value has yet to be created, simple purchase orders for pilot production runs are often used. The brand is fully at risk for all work flow and quality issues and has no guaranty of production capacity or locked-in pricing.

Once initial traction is achieved, a long form “requirements” kind of deal is much more attractive and stabilizing and can include many elements that ensure quality and supply chain optimization, but they often come at the cost of exclusivity and production minimums that represent real risk for the brand.

Long-term distributor or broker contracts that have exclusivity and termination fees often represent the single biggest structural threat to a brand’s ability to grow. Being handcuffed in the ability to make an efficient change of partner can be extremely limiting. Even worse, deals that do not have performance standards or reporting obligations often leave a company with little to no visibility into the real-time performance of its products at the retail level.

There is a real danger of paying retainers to too many agencies for too many things too early in the company’s launch process. Virtualizing a salesforce or bringing on a broker will reduce a new company’s human capital overhead and the overhead burn, but the company is still effectively committed to spend cash. Those retainers will be particularly painful when the company hasn’t yet achieved product-market fit and there is insufficient sales traction to justify the costs.

Often these relationships make more sense as an expansion tool when the company is at a slightly later stage. That said, retainers may make more sense in the early going when a brand can link up with a top-tier service firm, where such firm is in high demand and can afford to be selective in its clients. In that instance, the retainer is effectively the cost of entry for the brand.

When selecting a partner, the relationship is everything. Entrepreneurs should find partners that subscribe to the vision for the company, including the pace and method of rollout and expansion. Service providers should have experience working with early stage companies and should be willing to engage on flexible terms.

Second, entrepreneurs should perform due diligence. They should select partners based upon strong references from other brands and should check with other industry players to see how the potential partner is viewed.

Last, early-stage food and beverage companies should pick firms that understand that things will go wrong — because things always go wrong. Having a smart, flexible, constructive, and proactive extended team ensures that the problems will be fixed quickly and allow the company to reach its full potential.