Manufacturer’s Representative, Distributor and Dealer Arrangements
An essential part of the startup's plan will be the marketing and distribution arrangements for its products or services. As the startup progresses in stages from design to product development to production, it will be well advised to begin to plan its marketing and distribution strategy and organization. In this connection, there are three principal factors to be determined: (1) Type of sales organization (e.g., manufacturer's representative agreement, distributor or dealer agreement, value added reseller (VAR) agreement, license agreement or consignment agreement); (2) Products to be sold; and (3) Geographic area in which the products will be sold and distributed.
The type of sales organization will depend on the products and market for the startup's products. For example, if the company's business is making and selling consumer products, a multitiered distribution arrangement would be required, including a distributor or wholesaler level and a dealer level. The startup's contractual arrangements would be with the distributor, which would in turn develop dealerships throughout its territory. If the product is an electronics component or subassembly sold to original equipment manufacturers (OEM's), a manufacturer's representative agreement would be the likely channel of distribution. Such manufacturer's representatives usually sell a related line of products which are not competitive with the startup's products. If a startup's products are sold through chains, then a direct selling arrangement with the chains as dealers would be the appropriate channel of distribution. Where the company has limited resources, as is the case with most emerging growth companies, it will be to its benefit to try to find well established manufacturer's representatives, distributors, or dealers, as the case may be, which have established lines of communication with the relevant markets.
Manufacturer’s Representative Arrangements
A manufacturer's representative is an agent which sells the goods of a manufacturer or supplier within an assigned territory. The manufacturer's representative has limited authority as to the terms of sale, including pricing, and usually takes orders subject to acceptance by the manufacturer. The manufacturer's representative's territory may be exclusive or nonexclusive. Manufacturer's representatives usually carry a line of related but non-competing items. A manufacturer's representative neither has possession nor title to the goods that he or she sells.
Distributors and Dealers
A distributor or dealer is a sales representative which purchases the goods from the manufacturer and resells them at a marked-up price. A distributor or a wholesaler usually resells the goods to dealers throughout the distributor's territory, and the dealer in turn sells the products to the ultimate customers. Distributors and dealers both have possession and title to the goods, the distributor taking possession and title from the manufacturer, and the dealer taking title and possession from the distributor. A distributor may also be a franchisee. Distributors and dealers usually operate on an exclusive basis within an assigned territory.
Consignees and Commission Merchants
Consignees and commission merchants are selling agents with which the manufacturer places possession of, but not title to, products, for ultimate sale by the consignee, but as the property of the consignor. The consignee usually does not have control over the sale of the goods, and the consignor usually approves the terms of the sale and bears the risk of loss. The consignee may return unsold goods to the consignor. The commission merchant is also a consignee, in that it holds only possession, and does not purchase the goods. However, a commission merchant has some degree of control over the goods and the terms of sale, and may sell in its own name as well as that of the consignor. As the startup increases its market share and develops a reputation for its products, it may wish to internalize some or all of the selling activities by developing its own sales organization. Accordingly, it is important that the terms of its sales representative agreements, whether with manufacturer's representatives, distributors, dealers or consignees, should be carefully drawn so as to permit it to terminate such arrangements without risk of liability for wrongful termination.
Value Added Reseller (VAR)
Agreements In the computer industry, it is common for a hardware or software producer to sell its hardware or software product to another company which integrates the producer's product hardware or software products of its own and resells the integrated product. Such agreements usually provide for the VAR to receive a mark up of the price on the original product as well as profit on the VAR's product; but are generally structured to the particular application. Accordingly, they have a variety of designations such as VAR Agreements, Bundling Agreements, Developing Distributor Agreements, etc., based on the particular industry and the type of VAR being utilized to distribute the company's products.
Software Developer License Agreements
Where the software developer licenses its software to a licensee which is going to incorporate the software in its own product, a license agreement raises a number of issues peculiar to this type of licensing arrangement. Some of the key decision points are as follows: (a) Is the license to be exclusive or nonexclusive? (b) Is it to be limited territorially and as to field of use? (c) Are the royalties to be a fixed annual amount or an amount based on the number of units or dollar amount of products sold by the licensee? (d) Can the licensee sublicense the software to others? (e) Is the licensor to provide certain minimum maintenance of the software and to add improvements without additional royalty payments? (f) Who is responsible for providing user manuals if the software is to be resold? (g) What happens to the source code in the event the Licensor becomes insolvent or files for bankruptcy protection? Is the source code to be placed in escrow? (h) What are the warranty and warranty limitations? Are there any limitations on damages? (i) What is the term of the agreement and is it dependent upon payment of minimum royalties?
General Terms and Conditions
There are several common contractual provisions which should be considered, whether the sales organization is that of a manufacturer's representative, a distributor, dealer, consignee or value added reseller. These are described as follows: (a) Will the sales representative be granted an exclusive territory or not? If so, the manufacturer usually will agree not to sell to any other sales representatives in the territory; (b) Will the sales representative be permitted to handle competing products? (c) Will the sales representative be required to meet a certain quota? Will this quota be increased annually? What are the consequences if the quota is not met? (I.e., will the sales agreement be terminated, or be converted from an exclusive to a nonexclusive arrangement?) (d) What are the arrangements as to new products and product improvements? Will the sales representative be given an absolute right to handle all new products, or merely a right of first refusal? (e) What is the manufacturer's policy as to return of goods by the sales representative to the manufacturer? Should this apply to unsalable goods, defective goods, and inventory, upon termination of the sales representative agreement? (f) What is the method of compensation to the sales representative? In a manufacturer's representative agreement, the agent is usually compensated through a percentage commission on sales. In a distributor or dealer arrangement, the compensation is usually the difference between the purchase price from the manufacturer and the resale price, to either the dealer or the ultimate customer. Sometimes this discount is set forth as a percentage discount from the manufacturer's suggested retail price. (g) Will the agent be required to submit order approval to the manufacturer? This is usually the case with manufacturer's representatives, but not distributors or dealers, since they have possession and title to the goods. (h) Will the prices of the products be determined solely by the manufacturer? Will the manufacturer be required to give advanced notice on price changes and price reductions on existing inventory already sold to the distributor or dealer? Is the price maintenance by the manufacturer merely a manufacturer's suggested retail price, or an actual fixed price below which the distributor or dealer will not be permitted to sell? (i) The term of the agreement is extremely important. With a manufacturer's representative agreement, the term may be established for a definite period such as a year with automatic renewal unless either party notifies its refusal to renew the terms. Distributor and dealer agreements may have a longer fixed term if the distributor or dealer invests substantial sums in developing the market, purchasing inventory, or otherwise invests in the distribution arrangement; (j) The agreement should cover promotion, advertising and sales aids, and who bears the cost of same; (k) Termination provisions prior to expiration are very important, since early termination of distribution agreements has been the subject of considerable litigation, particularly in recent years as the covenant of fair dealing and good faith has been invoked by courts as a restriction on the ability of a manufacturer to arbitrarily terminate a sales representative agreement; (l) Limitations on authority of the manufacturer and the agent. Many sales representative agreements specifically provide that the manufacturer's rep, distributor or dealer, as the case may be, is not an agent of the manufacturer, or visa versa, and neither may bind the other party to any agreements. Such self-serving provisions in the agreement are probably not effective if the actual arrangements are those of a principal and agent, following traditional agency rules. The company's counsel should be sure to advise the company of this fact, so that the company does not have an unwarranted belief that no agency is created and that the sales representative is truly an independent contractor, as the agreement attempts to specify; (m) The manufacturer should establish a clear policy as to the handling of warranty repairs as well as the liability for warranted products. The warranty should be specifically set forth in the agreement, with provisions for procedures in handling defective goods returned under warranty.
The startup should, to the extent possible consistent with its bargaining position, try to develop standard contracts with its sales representatives. It should attempt to impose its own form agreements, rather than use the forms of the sales representative. Its channels of distribution and its marketing may be hampered if it has different types of agreements with different distributors and dealers, which may have the effect of discriminating in favor of one or more sales representatives.