Is your 'change of control clause' going to cost you money on exit?

My client had come into a windfall and gained an unexpected large sum of money. In fact, I had helped negotiate this money on his behalf…

 However, my client had not:

  • Sold anything
  • Been bought
  • Secured a new round of funding
  • Sued anyone
  • Licensed anything
  • Done anything commercially different
  • Had anything bad or untoward happen to them
  • Been bequeathed an inheritance
  • Won the lottery

You may be wondering how and why, I was able to secure my client this nice sum of money. It was all to do with the ‘change of control’ clause that they had with a supplier.

The background and context

My client was a reseller of computer software. When they set up their long-term contract with their supplier, their supplier was a young software development company. Therefore, as with these things, it was not unusual for my client when they set up the contract to insist on a ‘change of control’ clause in their reseller contract. After all, with many young software developer companies you are often ‘buying’ into the relationship you have with the owners of the company. The last thing you want to do is for them to exit stage left, and leave you with a sub-standard and poorly maintained product that you have to keep supplying to your customers.

Why was the ‘change of control’ clause so important?

Once again it is not unusual for young software development companies to grow and then get bought out. After all, building up a software company so that a bigger entity buys it out is often the end game for many developers. However, anyone buying a company will be wanting to minimise their risk in buying the company. If you are buying a company you are often not just buying the IP, but buying up the long-term contracts that they have secured. The last thing you want to happen, as the new owner of a business, is for your suppliers and customers to legally cancel or renegotiate their contracts. However, this is what a ‘change of control’ clause allows them to do. The ‘control’ referred to is most usually corporate (ie. shareholder) control but it could even be control of the board. But the thing these clauses have in common is that allows the other business to terminate the contract if the supplier undergoes a change of control. (In another blog I will talk about what you need to do to protect your IP in order to ensure a smooth round of funding or sale of your business)

 How did the ‘change of control’ clause lead to my client’s windfall?

My client, the reseller, was approached by their supplier to ask to secure their long term contract with them – and agree that it exercise its rights afforded by the ‘change of control’ clause, in order for the sale of their business to go ahead. Now my client – being one of the software companies key routes to market, knew that they had been one of the major reasons for the software company’s success, and subsequent valuation when the owners exited. As a result, they felt that it was only fair that they were compensated for their effort when the company was sold. 

In effect, I negotiated for my client a share of the value of the software company, in return for not exercising its right of termination under the ‘change of control’ clause - i.e. when the software company changed ownership, my client received a windfall as a ‘thank you’ for all their hard work in reselling the software company’s products.

In summary:

Well before you think about going for another round of funding or selling your business, see whether you can remove any ‘change of control’ clauses in your contracts. It could be a very costly move to leave them in there…