This article is written by Shivam Sharma pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
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India was the third-largest start-up market for the year 2020. Its valuation stood at an impressive USD 11.8 billion. Fuelled by finance from private equity and venture capital, the growth in the start-up market is unprecedented. Yet nine out of ten startups in India witness a decline in their revenue. An important factor in this decline in revenue is an inability to reach out to new customers. One possible solution to this obstacle is an Evaluation Agreement.
This article explains what an evaluation agreement is and why is it important for startups. But the importance of evaluation agreements is not restricted to mere start-ups, it also extends to the potential clients of the start-ups. The article explains the numerous clauses in an Evaluation Agreement and illustrates these clauses with the help of a sample clause.
What is an Evaluation Agreement?
It is an agreement between two or more parties. The parties under the said agreement agree to test and evaluate a new product or service offered by one of the parties. The purpose of the agreement is to evaluate the said product or service and in case the results of the evaluation are positive, further negotiations are undertaken to facilitate a sale or subscription of the product. Such agreements are limited by time and scope. Time, because the evaluation is to be done in a small duration which usually spans a couple of months. Scope, because in usual parlance, the product offered for evaluation is devoid of some of its capabilities during the evaluation period. This is because the business offering its product under the Evaluation Agreement wants the other party to purchase such product and unlocking all premium features is one way to incentivize such purchase.
Why do startups need Evaluation Agreements?
There are two main reasons for the same:
Getting new customers and pushing the sales numbers
Since start-ups have little to no recognition in the market, it is hard for them to sell their products to potential customers. Most potential customers are cautious in using new software, especially when such software has only been lab-tested. The Evaluation Agreement offers a trial run for such software and the customers get to see and feel their level of comfort and compatibility with the product offered. If the trial run shows positive outcomes, it becomes much easier for both parties to negotiate and facilitate the final sales.
Testing of the waters
As stated above, most softwares are developed and tested in a lab environment and their interaction with real-world elements is often unpredictable. A trail run facilitated by the Evaluation Agreement is a necessary feedback mechanism for any new software start-up. This ensures that the start-up has enough room for fixing any discrepancies in their product and also to make necessary tweaks as per the unique demands of a potential customer.
Why are companies interested in such agreements?
The true purpose of an Evaluation Agreement:
To check whether the product offered is a good fit
Every business has its own set of unique challenges and problems. To counter them, companies require innovative products. Usually, these products come from new startups who haven’t yet proved themselves. On top of that, the company is not certain whether the product offered is indeed the requisite solution to the problem it is facing. By entering into an Evaluation Agreement, the company gets to test the product and see how much reliance it can place on both the product and the start-up offering the product.
Pursuit of potential avenues for investment
In addition to solving the problems they are facing; businesses are also looking for expansion in businesses that are new and untapped. A new business usually offers potential exponential growth. If a company finds that a start-up has the right idea, the right execution of that idea and the right people to execute that idea, it will invest in that start-up. The Evaluation Agreement helps the company make such an assessment.
Types of Evaluation Agreements
Broadly, Evaluation Agreements are of two types:
These agreements do not include a purchase/license clause. This means that once the period of evaluation expires, the other party does not have the option to buy the software. The parties have one of two options. Either both the parties go their separate ways or they come together to negotiate the terms of purchase of the software from the start-up.
For instance, company A sells anti-viruses. It enters into a Short Evaluation Agreement with a potential client, Zee Ltd. The term (duration) of the agreement was 3 months. At the end of the 3 months, Zee Ltd. came to the conclusion that the anti-virus offered by A is very useful for its operation. Zee Ltd. cannot simply buy the anti-virus from A, as there are no purchase clause present in the Short Evaluation Agreement. Now, A and Zee Ltd. will have to negotiate a new agreement in order to make the sale-purchase happen.
These agreements do include in them a purchase/license clause that allows the other party to continue using the software even after the expiration of the term of evaluation. The most imperative part of the agreement is the clause of purchase and license. Thus, the entire agreement, which includes the terms of purchase of the software, has been completely negotiated even before the term of the evaluation period has begun. At the end of the evaluation period, there is no pressing need to renegotiate the terms as in the case of Short Evaluation.
Continuing the example given above, let’s assume that company A entered into a Long Evaluation Agreement with XYZ Ltd. The duration of the agreement is 5 months. At the end of the said 5 months, XYZ Ltd. wants to purchase the anti-virus from A. This time, XYZ Ltd. can simply buy the product under the existing agreement as the Long Evaluation Agreement contains the option to buy the product at the end of the 5-month term. There is no requirement to get into new negotiations.
Important clauses in an Evaluation Agreement
Having seen what is an Evaluation Agreement and why it is required, we now see some of the most important clauses under an evaluation agreement:
Purpose of the evaluation
This is generally found as part of the recitals of the agreements or follows as a separate clause immediately after the Recitals. It defines the purpose of the evaluation; what are the products and services which are being evaluated and; what are the offered products and services trying to accomplish. It also restricts the scope of the agreement by putting a cap on how the product could be used by the potential customer.
Intellectual property (IP)
Perhaps the most important aspect of the entire agreement. The agreement must succinctly:
- Define what is the meaning of ‘intellectual property’ in the context of the agreement;
- Make the above definition as broad as possible;
- Make it clear as to who owns the Intellectual Property;
- Make it clear that the other party does not own the said Intellectual Property and will have no rights over the IP offered, post the evaluation period under the agreement.
This is also the clause where the start-up can inculcate all feedback, results, and any other relevant data to be part of the IP. This way the other party becomes duty-bound to revert back such important information to the start-up. Another addition can be an explicit statement declining any share in profits to the other party which has accrued as a result of the above-stated feedback. Most importantly, this section protects the IP of the start-up. The other party gets barred from using or copying the software in any unauthorized fashion.
Return of IP and confidential information
This clause mandates that once the evaluation is completed, the said IP must be returned and all confidential information must be destroyed. It is important to note that the Confidentiality Clause will not cease to operate with the determination of the agreement. Instead, it will be binding on all the parties to the agreement, long after the agreement is terminated.
Term of evaluation
This is a simple clause. It defines when the evaluation period begins and when it ends. In usual parlance, such a period begins with the effective date of the agreement and ends on a specified date under the agreement.
Who is obligated to pay for any expenses that arise for the evaluation itself? What shall be the mode of payment of such expenses? When are these expenses to be paid? All these questions are answered under this clause.
Evaluation and review of the process
This clause establishes who will be conducting the evaluation and whether or not the evaluation itself will be supervised by someone representing the start-up. It can also prescribe the forms and files which need to be maintained concerning the evaluation. Such forms and files become important for the start-up as they offer indispensable feedback.
Disclaimer and limitation of liability
New software is as much a threat as it is a fix. The software may end up damaging the business of the potential client. Thus, it becomes imperative that the start-up defines the acts for which it is and the acts for which it is not to be held liable. It is also imperative that the damages themselves are capped. For a startup, this clause must be as broadly defined as possible.
Evaluation Agreements are a boon to start-up businesses. They are a safety net for start-ups in that they allow them to share their intellectual property without the fear of their IP getting stolen. Start-ups also get invaluable feedback from potential customers. Yet, as indispensable as these contracts seem to be, they are in no way easily negotiated. Small start-ups might face a great deal of resistance from companies in terms of the restrictions on use. Still, the Evaluation Agreement will inevitably play a larger and greater role in the coming years for software startups.
Sample Evaluation Agreement
Product Evaluation Agreement
This Evaluation Agreement (hereinafter referred to as “Agreement”) is entered into on this 6th day of July, 2020 (the “Effective Date”)
InfoSoft Pvt. Ltd, CIN XXXXXXXXXX, a private company established under the provisions of Indian Companies Act, 2013 and having its registered office at 31 Vir Bhuvan, JVPD 10th Road, Opp. UCO Bank, Juhu Vile Parle, Mumbai, 400049 (hereinafter referred to as the “Start-up” which expression shall unless repugnant to the context or meaning thereof be deemed to mean and include its successors and permitted assigns)
BCAL Enterprise, CIN XXXXXXXXXX, a private company incorporated under the Companies Act, 2013 and having its registered office in Noida, Uttar Pradesh, India (hereinafter referred to as the “Customer” which expression shall unless it is repugnant to the context or meaning thereof be deemed to mean and include its successors and permitted assigns)
(Hereinafter the parties individually shall be referred to as “Party” and collectively as “Parties”)
Now the Parties agree as follows:
- That the purpose of this Agreement is to set forth the terms and conditions for the use and evaluation of products which are offered by the Start-up to the Customer which includes but shall not be limited to:
- Server appliances;
- Online tools;
- Software as service (SAAS).
2. The above-mentioned products and services (hereinafter referred to as the “Products”) are offered by the Start-up to the Customer on a temporary basis and the term of which shall be defined under clause 7 of this Agreement.
- That the Product provided by the Start-up to the Customer are for evaluation purposes only.
- That the Customer shall conduct such evaluation for a period of 60 (sixty) days from the evaluation order book date (“Book Date”) or the date of issuance of license keys for Products, whichever is sooner (“the Evaluation Period”).
- That at the expiry of the Evaluation Period, the Customer may purchase the Product from Start-up at the current list price.
- That at the expiry of the Evaluation Period if the Customer chooses not to purchase the Product, the Customer’s subscription to the Products of the Start-up under this Agreement shall automatically be terminated.
- Intellectual Property:
- That all rights owing to the Products are there with the Start-up and its licensors.
- That the Products under this Agreement are offered to the Customer only for the purpose of evaluation during the Evaluation Period;
- The Customer shall have no right to and shall not engage either directly or indirectly in:
- Copying of the Products;
- Reverse engineer or disassemble the product with the objective to discover the source code or algorithm of the Products;
- Transfer, sub-license, rent, lend, lease or otherwise distribute the Products without the explicit authority of the Start-up.
- Modify or alter or in any way create derivative work of the Products without the authorisation of the Start-up.
- Use the Products for any other purpose except for the one defined under the terms of this Agreement.
4. Use the Products after the expiration of the Evaluation Period.
- Return of Intellectual Property:
- That the Customer shall have no rights to use the Products after the expiration of the Evaluation Agreement.
- That all the rights, title, interest and property to the Products under this Agreement shall remain with the Start-up and its licensors.
- That the Customer shall be liable for any damages or loss caused to Products or the Start-up owing to the Customer use of the Product after the expiration of Evaluation Period or the use of the Products by the Customer in any manner which goes against the terms of this Agreement.
- Term and Termination:
This Agreement shall commence from the Effective Date and shall terminate at the end of the Evaluation Period unless it is terminated by the Start-up beforehand.
- Limitation of Liability:
- During the Evaluation Period, the Start-up shall provide each Product as is and the Start-up makes no express warranties, express or implied, with respect to such Product.
- To the extent permitted by the applicable law, in no event shall the Start-up be liable under the provisions of this Agreement for any negligence, incidental, special or consequential damages of any kind, or any economic loss arising to the Customer owing to the use of the Products of the Start-up.
The Parties agree:
- That the Parties shall retain in confidence all the information disclosed by a Party to the other Party in pursuant to this Agreement which is designated to be confidential.
- Notwithstanding the above clause, the Start-up may collect Customer Confidential Information for the purpose of further data analysis by the Start-up.
The Parties agree:
- That all expenses for using the Product during the Evaluation Period by the Customer shall be borne by the Customer exclusively.
- That the Start-up shall not be held liable for the payment of any expense or for any reimbursement incurred by the Customer during the Evaluation Period.
IN WITNESS WHEREOF, THE PARTIES HAVE CAUSED THIS DEED TO BE EXECUTED THE DAY AND MONTH AND THE YEAR ABOVE WRITTEN.
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