Agency vs SaaS contracts - 4 Red Flags
I’ve seen hundreds of MSAs for SaaS projects and there is definitely a pattern of ‘suspect behavior’ that if you are looking out for, you can head off at the pass.
I want to emphasise from the start that I’M NOT A LAWYER. Have no training in law and therefore not qualified to give legal advice. However, I am a seasoned entrepreneur who has seen his fair share of Master Service Agreements (MSAs) or red-lined versions of my own MSA to know what to look for. If you have these simple flags to watch for, you can make the call as to whether to argue them yourself, or whether to pull your lawyers in to help (but when in doubt, you should probably speak to someone who is qualified!).
The problem with SaaS and client-created MSAs.
As a SaaS company, especially a startup one, you can often feel like you’re being bullied by your enterprise customers who insist that you sign their MSA rather than them signing yours. If you can, you should push back, but in the real world, we know that winning the work and taking the hassle of reviewing and signing the customer’s MSA might just be something you have to suck up.
But the problem with client-created MSAs is that they are often created by in-house lawyers, cut and pasted from previous ‘technology’ agreements, with no real understanding of what SaaS is. Nine times out of ten, you’ll be presented with what feels more like an MSA you would give to a contractor or agency creating some original work for a client, rather than a subscription to an existing service. Funnily enough, the type of contract that, as an agency or consultancy, you have seen hundreds of times yourself!
But agreements for consultancy projects are not fit for purpose for SaaS contracts. And it’s not even close. The problem is, if you just ignore them and hope for the best, they could come back and bite you hard. The following red flags are the one that I’ve often seen and should be jumped on by you as a founder. Ranked in order of disastrous potential.
Red Flag #1: Intellectual Property Ownership
IP is complicated if you are a consultancy building something for a client: there is ‘background IP’ (ie the IP you already have that belongs to the consultant and will continue to belong to the consultant after the project) and then there is the IP that the contractor is being paid to produce for the client. Naturally, they want to make sure there is no question over the fact that they own what they are paying for.
As a result, you often see client MSAs having something in there about how they will own the IP. Here’s an example:
All Deliverables or work product produced for Buyer hereunder will be Buyer’s exclusive property. As and when any Deliverable is delivered to Buyer, the ownership of such Deliverable will immediately vest in Buyer.
But as a SaaS company you aren’t building them anything bespoke (unless you are and if you are, the main SaaS element will need to be carved out). This isn’t you being pedantic: any sniff that they own any of your IP has to be removed. This is central to your whole business. If you suddenly don’t own the IP to your own platform then you are screwed. This includes the existing IP, but also anything that you develop going forward on your platform whether or not you did that to improve things for a specific customer’s benefit.
Would a customer enforce this and stop you from providing the same service to anyone else? I don’t know. But anyone investing in, or anyone buying, your company will run a mile if there is some question that your IP isn’t owned by you.
Any doubts, speak to a lawyer. Under no circumstances allow any aspect of your platform to be owned by anyone but your company. This is absolutely non-negotiable.
Red Flag #2: Non-compete clauses
Sometimes you might see something that says that you can’t sell a similar service to a similar company or in a similar territory. Possibly there is a time limit on it. Maybe it’s based on the end date of the engagement between you and your customer. But essentially it is an attempt to limit who you can sell your product to in the future.
Again, possibly makes sense if you are building something bespoke for a client as a consultant and there is a lot of proprietary knowledge you are being given. But as a SaaS company it’s a total non-negotiable.
The whole basis of SaaS is that you have solved a problem for a group of customers that is universally felt. The benefit to them is they don’t have to spend the millions of dollars you’ve invested to solve the problem themselves and can subscribe instead. The benefit to you is that you can get enough people to subscribe to the service to more than cover the time and costs you have sunk and continue to sink into it.
Suggesting that you can’t sell it to anyone else is dumb. If they want something unique, they need to create it themselves, otherwise enjoy the fact that they get all of the multi-million dollar R&D functionality for the cost of a subscription. There is another consideration too: many SaaS companies have a self-serve function, so even policing a non-compete would be pretty much impossible.
And finally, if you are ever thinking of raising money or selling your business your non-compete will have to be declared as part of the due diligence and will impact your value. Who wants to buy a company that has one hand tied behind its back?
Red Flag #3: Uncapped Liability
Another favorite is either uncapped liability or liability that is grossly OTT for the level they are paying you. Under the ‘Limitations of Liability’ section you might see something like this:
Each Party will be liable to the other Party for any direct damages arising out of or relating to its breach of this Agreement provided, that the liability of a Party to the other Party for direct damages, on a per occurrence basis, under this Agreement will not exceed $5 million.
If you are being paid a few thousand dollars a year in subscription revenue, having a liability that is either uncapped or set at something like $5m feels a bit unbalanced. You might think, well it goes both ways, but let’s face it, it’s unlikely that you will ever have a claim against them. It’s far more likely if anyone is doing the suing, it will be them.
What’s more, your Professional Indemnity insurance might not allow you to cap your liability at the level they are suggesting. Regardless, it has to be reasonable.
Typically you should be able to suggest either the sum, or twice the sum, of the total amount of fees they have paid you in the previous 12 months (and over the lifetime of your relationship together, not per incident).
In my (no lawyer) experience, this is the one that they often don’t like to negotiate. But 12 - 24 months’ worth of fees is very typical and you shouldn’t feel bad insisting on it.
Red Flag #4: Termination for Convenience
This is a classic - and is more cheeky than disastrous - but it’s a bug bear of mine. In a contract there will of course be an allowance for what happens if you don’t provide them with a service, or the service you provide isn’t what you sold them. In that case you would be in breach of contract and they could withdraw - which seems fair enough. But it’s the seemingly innocuous clause titled, ‘Termination for Convenience’ that frankly takes the piss. You may see some wording like this:
Buyer may terminate this Agreement, in whole or part, at any time without cause, upon at least thirty (30) days’ prior notice to Seller.
It basically means even if you’ve provided the service as you were supposed to, they can just cut the contract short because they feel like it.
But if they sign up for a year’s contract, they don’t get to cancel after 5 months just because they feel like it. This is because the cost of acquiring the customer and onboarding them etc is all factored in to an annual subscription price. It wouldn’t work if you or I tried to pull that on our mobile phone contract or a gym membership: especially if there was a discounted rate for taking up an annual subscription over a monthly one.
Would it be a deal-breaker? Probably not for a big enough client, but you may have some leverage if you publish a more expensive monthly rate on your pricing page and can just respond with something like: “if you want to terminate for convenience on 30 days’ notice that’s totally fine, but you would need to move to the monthly subscription rate which is 20% more expensive”. Then see if the extra cost is ‘convenient’ or not. Hint: it’s probably not.
If you can keep an eye out for these things, chances are you are making any real lawyer work a bit less onerous if and when you have to start paying external counsel for advice. At least negotiate these things first. You should feel confident that if you push back on any of them you will probably not get too much resistance as they are all completely reasonable (and in some cases, vital).
But remember my caveat that I’m not a lawyer and this is more of a guide than any actual advice you should rely on!