Get it Right the First Time: SaaS Contract Best Practices with Ben Oelsner
Enterprise deals can get stuck in negotiation for a number of reasons. From establishing expectations and terms to dealing with purchasing or legal departments, each step of the sale carries some potential roadblocks. The bigger the deal, the stickier it can get, especially for startups.
This is why Ben Oelsner and I hit it off when we met at last year’s SaaStr Annual conference. As a co-founder of law firm KO (Koenig, Oelsner, Taylor, Schoenfeld & Gaddis PC), Ben specializes in SaaS contracts.
Ben is a mentor at TechStars and spends most of his time in Boulder but started his legal career in the Valley. He's a fantastic resource for Silicon Valley companies as well as international startups who do business here.
Ben was kind enough to sit down and answer some of my questions about drafting and negotiating SaaS contracts. Here's what he had to say:
Long Contracts vs. Click-through Agreements
SalesCollider: Someone told me to ditch the long contract and just go with a short order form with a link to a Terms of Service on my website. Is that a risky move?
Ben Oelsner: There is some incremental legal risk with click-through agreements. They might be a bit more difficult to enforce than signed agreements because it can be easier for a party to claim that it is not bound by a click-through type of agreement. However, the business benefits of a click-through agreement may outweigh the risks. The efficiency of the contract process makes it easier for customers to agree to your terms. This can lead to more customers and, thus, more revenue for the company.
The real risk is that, as your customer base moves into larger companies with more legal resources, they may resist or reject online agreements. Large customers will have more leverage to negotiate an agreement. Obviously, they can’t do that with an online agreement. Additionally, most online contracts are favorable to whomever drafted it. Onerous or unreasonable agreements can create problems with deal flow. If customers actually read them, they won’t agree to the terms without making changes.
I advise my clients to let me help them create an agreement that is more even-handed and more easily agreeable by the customer. You can remove or alter provisions in the form that you know your customers will object to or want to revise. Then, you can structure the agreement process as an online agreement. You can also make a signed agreement version to be used when requested by the customer or as the contracting process changes.
SaaS Contract Templates
SC: My accelerator provides a pre-written SaaS contract template. If I’m with Y Combinator, for example, shouldn’t I just use their SaaS contract instead of drafting up my own?
BO: There are two things that can go wrong if you’re using the YC SaaS Agreement. First, that form may not have the necessary terms for how your SaaS solution is provided. Second, using the YC SaaS Agreement is likely to create more friction with your customer during the negotiation process. This will slow down your contracting process, increase the cost of closing deals, and could cause you to lose deals altogether.
The Y Combinator SaaS form is a solid agreement. Its authors knew what they were doing when they put it together. However, it is clear from the comments and optional language included in the agreement that they knew it shouldn’t be used by every SaaS company in every situation.
Any template needs to be customized according to its specific use case. Otherwise, you risk using an agreement that doesn’t meet its objective. The reason to enter into an agreement is to set out the legal documentation that addresses the rights and obligations of each party based on their intent. A contract that doesn’t reflect the services provided cannot accurately capture the intent of the parties and is thus more susceptible to dispute (which is the last thing you want).
Also, since they made the agreement unnecessarily vendor-favorable, anyone who actually reads it will have a number of objections and will probably request for provisions to be deleted or changed. Using a form agreement that reflects the value of your SaaS solution, and does so in a reasonable way, will save you time and ultimately reduce the cost of closing deals.
If you’re thinking about using a contract template, my recommendation is that you have someone with experience help you customize it. Review the agreement as if you were the customer and think about whether you would agree to it if it was sent to you.
Enterprise SaaS Contracts
SC: Let’s say I’ve just gotten my first enterprise deal. It’s a big kahuna. This will just be on their paper, right? Should I bother sending them my own contract? Do big companies ever sign the little guy’s paperwork?
BO: It never hurts to send an enterprise customer your agreement because if you’ve taken the time to make it reflect your business, it will be a better agreement for your services. Big companies will often agree to use the form of their vendors for this very reason, especially if your contract is well-written and reasonable.
Act like your agreement is the only one to use but don’t be surprised if they send you theirs. Understand that the only way to get their business is to use their form and that there will likely be additional time and cost to you because it will probably have to be modified and negotiated.
SC: What if 80% of my customers ask me to take out the automatic renewal clause. Is there a better way I can include this? Also, if we do auto-renew and the company doesn’t pay, what happens? Do I sue them?
BO: I think that auto-renewal provisions are almost always the best way to go as a default provision for SaaS providers. It can often eliminate the situation where the contract expires but the services continue because nobody is paying attention to the expiration date. However, many companies simply won’t agree to auto-renewals as a matter of policy. A typical, well-written auto-renewal clause will include the concepts of “Initial Term” and “Renewal Terms” which are defined together are the “Term.”
It is good practice to have backup language available that leaves these terms in but modifies the structure so that the agreement only renews if both parties agree upon that in writing. As always, make sure you note the expiration date as well as the dates 30 and 60 days before expiration. Also, create a simple document that allows for easy renewal of the agreement without a negotiation. You want to give the customer the maximum amount of notice and make it as easy as possible for them to renew.
International Startups in the U.S.
SC: My company is currently based in Europe but we’re heading to the U.S. to set up our first international office. Should I expect any different practices when closing SaaS deals with my current contract? Do I need to rewrite anything?
BO: It depends on what your current agreement says. However, the one item that will probably need to change is the governing law and venue/jurisdiction section. It is unlikely that any U.S. company will agree to a contract that is governed under the law of any territory other than state law and no U.S. company is going to agree to handle contract disputes in Europe. It may be easier to have a U.S. subsidiary that is a party to the agreement and to govern the contract in a state like Delaware or New York. An arbitration provision may be a compromise position that is acceptable to both parties.
Early Termination and Refund Clauses
SC: What is the standard language for early termination and refund clauses?
BO: The typical places in the contract that will reference termination and refund are:
Termination for performance warranty breaches
Termination for clause
Termination for convenience
Termination rights in the indemnification section
Each one of these will contain different language. A SaaS provider will want the payment provision to say that all fees are non-refundable except as expressly set forth in the agreement. Here are four common scenarios under which a refund could be paid:
1. Performance warranty breaches
The SaaS provider warrants that all services will perform as specified. If there is an error, the SaaS provider should correct the error. If the error cannot be corrected, the customer will want to terminate the agreement and get their money back. If the customer has paid for the services in advance, then it is not unreasonable for them to receive some refund.
Of course, the question is how much should the refund be. A reasonable amount would be the prorated amount of the prepaid fees for the time period after the agreement is terminated. The reason a refund is reasonable is that the customer will not receive post-termination services for which it has paid. However, the customer should not necessarily receive all of the prepaid fees for services already provided. If the warranty breach occurred within the first 30-60 days, a full refund may be reasonable.
I also recommend that the refund be the customer’s only remedy for warranty breach, so the SaaS provider is not liable for any additional damages that the customer may claim they suffered, in addition to the amount paid.
2a. Uncured breach by SaaS Provider
The scenario is similar to the performance warranty breach. It is broader, however, because the termination results from uncured breaches of other terms in the agreement. If the customer has paid for the services in advance, it is not unreasonable for them to want a refund of the prorated amount of prepaid fees for the time period after the agreement is terminated.
2b. Uncured breach by customer
The SaaS provider will not want to agree to refund any fees if it is terminating the agreement due to an uncured breach by their customer. This termination right could be exercised if the customer is using the service in a way that violates the terms of the agreement. However, the most likely scenario for a SaaS provider to terminate the agreement for breach is when the customer has failed to pay the amount due. It is possible, therefore, that there may not be any fees to refund anyway.
3. Customer’s termination for convenience
Although SaaS providers generally oppose giving customers the right to terminate an agreement early without cause because the parties have agreed to a specific term (and possibly have received favorable pricing for commitment to such term), many customers will insist on the right to terminate.
The neglected issue will be whether the customer receives a refund if it terminates the agreement without cause. The customer’s argument is that they should not have to pay for services they don’t receive. However, the SaaS provider may have an argument that they shouldn’t have to refund any pre-paid fees. The customer is merely making a business decision to walk away from the deal. The cost of the customer losing those fees should be considered when making that decision because, (i) the customer committed to the entire term and should have to pay for that term regardless of whether they decide later to terminate it without cause, (ii) the provider may have spent a significant amount of money to implement the services and (iii) the customer could have received most, if not all, of the benefits from its usage of the services during the initial months of the term.
4. Termination in connection with indemnification
Although this termination right is highly unlikely to be exercised, it is not unusual for the SaaS provider to agree to refund a prorated amount of prepaid fees if there is a third-party infringement claim, the provider cannot modify the software to avoid infringement and the customer will not be able to use the service any longer due to such claim. However, the refund agreed upon should never be the entire amount paid by the customer under the agreement.
Master Service Agreements
SC: How does a Master Service Agreement (MSA) compare to a regular contract? Do big companies accept that we have an MSA in place?
BO: A master service agreement is drafted to permit multiple orders for increased usage or for different kinds of services. A standard services agreement is really just for a one-time purchase for the services set forth in the agreement. It can always be modified by agreement of the parties. However, it wouldn’t have the built-in flexibility to add more orders that an MSA has. The benefit to the parties is that, if more services are ordered, the agreed upon terms of the MSA would be used. Then, the specific new services and business terms would be set forth in a new order or SOW that would be incorporated into the MSA. The parties would not have to negotiate the terms.