Distribution agreements are a much needed tool if you’re looking to outsource selling or manufacturing of your product.
Distribution agreements are agreements between two parties generally who are trying to fill a void within their own business. So let’s say you manufacture a product, but you don’t have the sales force or knowhow as to where to sell that product or how to sell that product.
You can outsource through a distribution agreement to an existing sales force. Who can do that for you? If you in turn are a sales force that doesn’t want to produce your own product or your own widget, you can be the go to person for a widget of some kind that helps those companies sell their products in any given territory that you gain.
This is a very, very common set up in the cannabis industry, but really industries the world over for all sorts of products. Distribution agreements help companies fill the void for parts of their business that they either don’t want to spend money on or they don’t have the personnel for or they don’t have the facility for it. The thing about distribution agreements is that necessarily they’re always going to end at some point because as the distributor, at some point you’re going to have done your job too well and the manufacturer is then going to have the money to hire their own internal sales force.
So when you’re drafting a distribution agreement, you need to understand from the outset that it’s going to be unlike, say, a lifetime agreement, like an operating agreement or a partnership agreement, which you’re hoping will last forever, potentially, you know that these agreements will end. So your exit strategy is as important as your entrant strategy. And drafting these agreements is your only protection in the end as to your rights, both during and after your relationship, your success in this business relationship is wholly determined by how well you draft and negotiate your distribution agreement.
Let’s talk about what goes in a distribution agreement.
Essentially, it’s the terms by which the sales force or distributor provides services to the manufacturer or wholesaler, wherever you may be in the supply chain. There are a variety of terms that come in these agreements and are very dependent on industry and type of relationship. Is it exclusive? Meaning you’re the only sales force for this company or is it not exclusive?
Meaning you’re one of many. Is it what’s the territory ownership of product generally? The manufacturer or wholesaler is going to want to maintain ownership, but you as the sales force, especially in a long term contract, may decide that you need to have some approval of the product or you don’t want to have any approval of the product and you want to make sure that the agreement lays out that any product liability, i.e. when it becomes defective and somebody gets hurt or a consumer doesn’t like it or wants to return it, that that liability doesn’t land on you as the distributor and stays where it should with the fracture delivery.
One would not think that that’s a complicated term. But let me tell you, when you are talking about product that it has to be delivered on, time delivery becomes very complicated. Let me give you an example. You, the distributor, have an agreement with a manufacturer. You submit a whole bunch of purchase orders for a thousand widgets to be delivered on a certain date, that you were then going to turn around and deliver to other buyers.
If the manufacturer has a problem in their factory and suddenly you can’t get a thousand widgets, you can only get 50 widgets and you can’t get them. But for two weeks from now, then you might lose the interest of those sellers, of sorry, of those other people that you’re selling those widgets to, which then could affect your ability to perform your distribution and agreement contract.
So what does that mean? You, as the distributor are screwed. You need to have provisions in your distribution agreement from the outset that in that event you don’t get penalized for nonperformance. And addition to that may be the manufacturer has to bear some of the cost of making things right with those buyers. Otherwise you’re going to be left holding the bag.
It is often beneficial to make sure that your agreement is exclusive, otherwise you’re going to be competing with other people in the same industry, potentially in your same territory. If it’s exclusive, though, generally that has to come with some sort of consideration. Meaning are you having to buy the product from the manufacturer? Is it commission based? These are things you need to work on at the outset.
There’s not much advantage if you have to buy the same product as everybody else with little to no discount. A lot of times distributors want to work out a commission based agreement. Therefore, performance, it’s what is what’s tied to the cost, right, of inspection. Go back to our delivery example. So thousand widgets do arrive on time. However. 300 of them are defective.
They won’t work. How long do you have to determine that? Do you have a day? Is that enough time? Do you have a week? And how much? How long do you have to get that product back to the manufacturer? And what’s their responsibility to fix it? Because if you don’t have that negotiated at the outset, the manufacturer may say to you, well, things happen, defects occur.
That’s just, you know, things happens. But you, as the distributor, are now left holding 300 widgets that don’t work with nothing to do with. Oh, well, that’s not good. Not to mention, again, you may lose the interest of the buyers you’ve already got purchase orders with again, potentially affecting your performance. So right of inspection and the cure of any defective product are terms that must be negotiated at the outset.
Representation of competing products
So let’s say you are the premier distributor of a certain energy drink in the territory of the southeast of the United States. Now, if Monster Energy calls you and says, Hey, you guys are great, we want to work with you, but we want you to you can’t work with anybody else, but you’re already working for Red Bull.
That’s not going to work. So if you are already representing competitive products, you need to have it in the terms and you need to get your your wholesaler or manufacturers. Okay? Otherwise, they could come back later and say that you’ve materially breached the terms of the agreement unless it’s spelled out termination and ending of the relationship. As I said in the beginning, this is the most important part of these agreements.
How are you going to end your relationship? How long? What kind of notice is required? Is there? Are there thresholds for termination? Can you terminate for any reason? This is so often the problem in these agreements that in most of Europe, distribution agreements are required to have severance packages and long notice requirements and all sorts of other provisions by law.
We do not require that in the United States. So you need to negotiate those things for yourself. If there are non-compete clauses, how long do they apply? How strong are the provisions that prevent you from selling similar products in that territory? And for how long? And in the end, if you have products left over. Is the manufacturer required to buy it back from you?
If there are sales outstanding that come through after the termination of the agreement, do they have to pay you for those? These are all things that you need to consider in the termination of your relationship. Distributions agreements are a powerful tool to cut costs when you’re selling part of pretty much any kind. But the contract between the parties is the law when it comes to the relationship.
And so how well you negotiate it, how specific your terms are and how holistically think about all the potential issues that can arise. When drafting these agreements determines the usefulness and the protections of this tool and the relationship throughout the distribution agreement between the parties is the most protection that’s going to be given to either side throughout the relationship.
The strength of the agreement is what determines whether or not it will be a successful relationship. Negotiating this from after the relationship starts puts you in a weak position, which is not great. There’s no reason you have to do this alone. It’s very complicated. Give us a call today and we’ll help you figure out how to use a distribution agreement as a tool in your business.