For many small businesses, the key to success depends on how well you distribute your product. For example, if your company’s products are retail items (such as household decor, clothing, or kitchen appliances), you will be looking for an experienced distributor with a strong sales force and good contacts.
The distributor may then contract with dealers or large retail chains to sell your product. The key to your relationship with the distributor is the distribution agreement.
Although a distributor will usually want to use its own form of distribution agreement (which of course will be one-sided in the distributor’s favor!), you should at least give serious thought to the following key terms in the negotiations:
- Territory and markets: The contract must clearly describe the distributor’s territory or business area, and furthermore, the market or customer category. For example, if you want your company to directly handle certain major customers such as national accounts, and the distributor to handle other outlets, will their territory be broad (such as the entire country), or narrow (such as one city)?
- Internet and catalog sales: The traditional printed catalog and more recently the Internet are both “borderless” retail venues. Neither a catalog seller nor an Internet retailer can easily (or willingly!) restrict its sales to a traditional, physically defined territory. Internet and catalog sales can be profitable, but they can also generate problems if you have signed exclusive distribution agreements for particular territories.
- Exclusive versus nonexclusive: The contract should specify whether the distributor is to have exclusive or nonexclusive rights to the company’s products in a particular territory. Be careful here — you don’t want to give exclusivity for one territory or market if you face a risk of terrible sales performance by the distributor. If you are going to give exclusive rights, consider setting contractual sales targets that the distributor has to meet in order to maintain exclusivity.
- Obligations of the distributor: The distributor’s obligations must be spelled out. Ideally, you want a clause that says the distributor must use its “best efforts to market your products.” Because the distributor will resist using this phrase, consider setting forth in the contract specific steps that the distributor must take — contacting all the major potential customers, appointing dealers, preparing marketing material and promotional activities, and so on.
- Price: The contract needs to include a pricing section. Generally, the price follows a schedule or the seller announces the price from time to time. The seller then typically provides an agreed discount to the distributor. You need to be flexible on the price you charge for your products, and the contract should say that you can change prices from time to time with a stipulated form of notice to the distributor.
- Payment terms: Industry practices often dictate payment terms. Ideally, you would like to get an up-front deposit on a distributor’s order with full payment due either 30 or 60 days after shipment. Make sure that you are comfortable with the distributor’s credit worthiness. If you know someone who uses the distributor you are considering working with, ask them about the distributor’s payment timeliness.
- Price protection: If you lower the price on an item after a distributor has taken inventory but before that inventory is sold, the distributor will not be happy! Attaching a price protection (policy) guideline to your contract is a good idea. We have included an example Reseller Price Protection Guidelines in our Sales and Distribution Agreements CD kit.
- Product issues: You need to clearly identify the product or products that the distribution agreement covers. The agreement may also cover product availability and allocation of product among other distributors. (If a new product is selling faster than you can supply it, every distributor will want every unit you can supply!) The distribution agreement should also cover how the distributor will handle product inventory and what rights of return will be available.
- After-sales service: If applicable, you should decide the terms for servicing the product. Will the distributor handle product servicing or warranty claims? Does the distributor have the expertise to do so? How will you compensate the distributor for servicing the product?
- Trademarks and logos: The distribution agreement should prohibit the distributor from using your company’s name, trademark, and logos in advertising, point-of-sale activities, and marketing materials except as provided in the distribution agreement or with you prior written consent. This restriction is important to ensure that your company’s goodwill, reputation, and brand name are not hurt by the distributor’s activities.
- Contract term and termination: The distributor’s term of appointment and how such a term can be terminated or reviewed are very important issues in a distribution agreement. Try to get the right to terminate the contract for any reason, as long as you give at least 60 to 90 days of written notice. This allows you the option to get out of a relationship that just isn’t working. Also, add a provision that allows you to immediately terminate the contract if the distributor breaches its obligations or becomes bankrupt or insolvent, or is sold. You must also address the potentially complicated issue of what happens after termination with respect to products, sums owed, and servicing obligations.
Distribution agreements can be complicated and you should try to find out standard practice in your industry and see sample contracts from different distributors. Ask the distributors you talk to for copies of their contracts and any other terms of service they might attach to those contracts. Do not sign a distributor’s contract until you have studied it carefully and are comfortable with all the terms and conditions. Your business may depend on it!
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