Guy Reams (00:00.578)
This is day 318, how contracts turn belief into capital. This is probably not the most exciting topic to talk about, so you will most likely skip this one. However, I find these sort of things fascinating. Yesterday in a business meeting, we were discussing potential business models and how we would contract with our customers to provide a service. We were running into a classic dilemma.
We want the customer to sign up and use our service, but we also need to invest heavily in order to fulfill that service completely. Clearly, the service is not quite at the level that would produce the value that we believe we have the potential to deliver. But if we had a commitment from enough customers to use the service, then with that guarantee, we could invest the time, money, and resources into the service so that we could deliver that value proposition at some point in the future.
This is what I call the good enough problem. When you have developed something that is good enough for people to use, but it is not complete. As is typical, the last 20 % of effort is the hardest and the most expensive to accomplish. As a consequence, we need to start securing contracts, but we need to do so in a way that allows us to invest heavily in getting from 80%, or good enough, to 100 % worth the value of what people are committing to pay.
This is a risk in reverse strategy. As a company, we reach a point where we cannot take any further risks, so we want our customers to shoulder some of the risk in reverse. This sounds rather absurd, but in reality, this has become a highly common strategy for companies that find themselves in the we are good enough situation. The best example would be Microsoft in the 1990s when they moved to what was called an enterprise agreement or EA.
for clients above a certain user account. This is a basic economic model nowadays, and I see many startups trying to follow in these footsteps, but do they really understand why they would do this in the first place, I wonder?
Guy Reams (02:10.126)
To properly frame this, we need to go back to the 1960s and the explosion of the U.S. natural gas usage. Post-World War II, we saw a massive demand boom for natural gas. Suburban sprawl was at an all-time high, and heating these homes, plus the new industrial fuel switching and increasing power demand, created a perfect storm, where U.S.-based companies were rapidly trying to build out a main pipeline network that could reach these new population centers.
This happened and in reality most of our gas pipeline that is built out across the United States occurred during this decade. However, this was extremely expensive. So how did these companies figure out how to afford to put all this infrastructure in to meet the demand? Enter the precursor to Microsoft's EA commit licensing agreement. The TOP contract or what is commonly called take or pay.
The TOP contract is effectively the same instrument that Microsoft created in the 1990s. It is a commit to consume obligation that a customer takes on. This is a reverse obligation and it's an obligation in reverse instrument that helps to offset the cost associated with building a capital intensive supply chain. In this case, the massive natural gas pipelines that were being built out. In this situation, the basic agreement was this.
We are going to deliver you natural gas that is going to cost us considerable capital. In return, you are going to commit to a minimum usage and agree to pay at that contract price for the usage. If you have a shortfall, meaning that you do not consume the quantity that you promised, then you would pay for any shortfall or cover the gap that you did not meet. The beauty of this type of vehicle is that the company would draft this primary payment on the minimum amount as debt.
and not damages. Therefore, the pipeline company could enforce this contract as a debt instrument. This was a massive shift as the volume of purchase was shifted to the buyer. Now, often enough, the buyer in this instance was not necessarily direct consumer, but other companies, organizations, states, and large municipal governments who would then provide a service to their consumers. This vehicle allowed the gas pipeline companies to underwrite all of these contracts as cash flow.
Guy Reams (04:31.555)
therefore able to finance a massive capital raise to build out these pipelines. So next time you walk by the side yard in your house and you see that gas meter, realize that it was this marvelous TOP contract arrangement that made the vast natural gas pipeline throughout the United States even possible. Of course, when people and companies started getting hit with their deficiency bills, they were confused and upset by this arrangement. There are hundreds of state, federal, and even Supreme Court cases
where the merits of these contracts were battled out in the 60s, 70s, and 80s. However, the contract language ultimately won out and passed the test. The next industry to take advantage of this would be telecommunications, the software industry, wireless communications, and then eventually the cloud infrastructure business. This is no small matter. The United States absolutely dwarfs all other countries in terms of infrastructure build out in every category.
When you look at natural gas pipelines, the aggregate European Union comes close, but every other country is nowhere near the level of natural gas distribution as we enjoy in the United States. You want to know why some countries really struggle in developing urban centers? It's precisely because of this reason. Access to low-cost energy and communication infrastructure in the US is perhaps one of our greatest assets, and most of it can be attributed to the creativity behind the TOP contract.
I know as startup founders roll our eyes at the legal speak, all the contract language and the thousand plus hourly rates that transactional attorneys charge nowadays, but we must take a pause here and realize that contract instruments absolutely matter. Just look at what this did to the natural gas industry in this country. When you walk around and see cell phone towers all around your city, understand that this all had to be financed somehow.
I do not know exactly who was the brainchild behind the Microsoft EA agreement contract structure, but this ability to capitalize on unearned revenue was nothing short of genius. Microsoft was able to take a software suite that was considered just good enough and launch it to hundreds of millions of dollars in annual revenue by 1998. They went from just a typical box software company to a full annuity style licensing company.
Guy Reams (06:50.926)
In 1999, when Microsoft started reporting organizational licenses on their 10K as accounts receivable, the software business as we know it changed. Billions of deferred, unearned revenue took Microsoft into the next stratosphere. All of their competitors were shell shocked that this mediocre software company could rise so quickly and get so many enterprise adopters so rapidly. They did not understand the magic that was in the TOP contract.
So here's my simple encouragement to every founder who thinks contracts are dull. Sit with them anyway. Contracts are the bridge between belief and reality. They turn the promise of future value into present fuel. They let you move from good enough to truly great because they give you the right to invest with courage. The gas meters on our homes and the cell towers on our skylines did not arrive by accident. They were pulled into being by clear promises on paper.
that lenders could trust and that operators could build against. If your product is not yet complete, do not hide from that truth. Write it into the deal. Define what the customer will receive now and what you will improve and what each side will commit to so that the final result is worth the price. Put a number to the commitment. Put dates to the milestones. Put teeth in the payment terms. This is not busy work. This is the operating system of your growth.
When the world asks if you are serious, your contracts answer with a calm and steady, yes, we are. Make this practical. Block time with your legal counsel. Draft one standard agreement that matches your model. Add a commit to consume exhibit that is fair to both sides. Spell out what happens if either side falls short and what remedies will put the plan back on track. Create a version for small customers and a version for large customers if you wish.
Revisit the language after every deal and keep improving it. Each small refinement widens the bridge. In the early days, it will feel slow, but keep going. The habit of thoughtful contracting will sharpen your thinking about value, risk, and sequence. It will align your team, reassure your customers, and unlock capital you cannot reach any other way. Paperwork does not dim your vision, it focuses it.
Guy Reams (09:12.376)
Put your ideas into clauses and schedules and signatures and watch how the future becomes actually buildable. Do the boring work. It is how you earn the right to do the thrilling work. Contracts are not the enemy of innovation. They are the scaffolding that lets it rise.