Your business is your livelihood. It needs to be protected. Too many small business owners expose their businesses to risk and ruin because they do not have the most essential contracts in place to protect them. If you can’t sacrifice a pawn, you may end up losing your king. Businesses need to be strategic with their contracts and decide what is critical to keep and where they can or must let go. Most small-business owners are overwhelmed by trying to do their work and figure out how to run a company. Business owners often add contracts to the never-ending to-do list and feel frustrated when trying to figure them out.
Good contracts are handshakes with teeth. Done correctly, they capture the parties’ deal. Better still, your company’s contracts can be tremendous assets that lock down your rights to money, goods and services.
Here are the top 7 mistakes that turn contracts into liabilities:
- Not Legally Securing Your Intellectual Property
For an early-stage startup, more often than not, the only real asset it owns is its intellectual property. But nearly as often, when you dig down, the ownership of that intellectual property is less than clear. The reason for this is simple: most startups eschew formalities in the earliest stages of growth. They’re busy doing the common lean-startup stuff, such as customer development and interviews, development of the product, and early marketing and promotion. That’s what a startup should be doing. Unfortunately, an early-stage startup that doesn’t own its intellectual property usually doesn’t own anything. And a company with four part-time founders toiling away without any written agreements doesn’t own its own intellectual property. If one of the founders walks away and refuses to assign the work they’ve done after the fact, you will find yourself at the mercy of that founder in the negotiation. And if that founder refuses to assign the work they’ve done, guess what? You don’t own your own company.
If there’s one type of contract you have on day one as a startup, it should be a contract that memorializes the assignment of IP to the company. And every person who works on the company should sign it, not just the technical people. This includes contractors, developers, marketers or anyone else who contributes to what you do. Make sure you own their work. Or they’ll end up owning your company.
- Me, Me, Me — Alienate Everyone With A One-Sided Agreement
One-sided contracts often backfire. Sure, selfishness has a certain infantile "I-am-the-center-of-the-universe" appeal to it. If you’re short-sighted, you’ll use a contract that gives the other side no remedies even if your product or service fails. But, in the long run, karma and the courts have a way of evening things out.
Consider the following real-life provisions from a software agreement:
"Dynamo Ltd makes no guarantees that the software: (i) is suitable for the use intended by Customer, or (ii) contains no errors that may render the software unsuitable for Customer’s intended use. The Customer agrees to defend, indemnify and hold harmless Dynamo Ltd from all claims, liability, judgment and expense arising in any manner from use of the software."
Translation: Dynamo Ltd says, "You pay your money and you take your chances." Plus, if anything blows up, you’re responsible for the mess, not the software company.
But, then, the karma/court part kicks in. Ultimately, people will grow to hate your company and do what they can to avoid doing business with you. If you end up in a dispute, a court will be tempted to find your agreement is "unconscionable" and free the other party from all obligations. This is more likely to occur if you have a lot more bargaining power than the other side. Similarly, if you do business with consumers, regulatory agencies are eager to treat your company ruthlessly for bullying the "little people." You could be investigated, fined and even barred from certain businesses.
- Bad Drafting
More and more, people are doing business in tweets, texts and even emoji. Recently overheard from someone on a cellphone: "Like, you know, he sent me a smiley face with a thumbs-up. That’s probably his contractual yes, right?" Um, actually, no. In the hallowed roomss of Nigerian justice, they still want to see contracts drafted with a modicum of care and knowledge of the rules. Bad drafting torpedoes even the biggest companies and richest entrepreneurs. In 2018, a Nigerian industrial court threw out an arbitration agreement and allowed an employee to proceed with a class action because the contract was "confusing" and "ambiguous." In another case, Williams Aleshinloye’s estate lost 7 Billion because of a badly drafted guaranty. A Nigerian Bank jeopardized a loan for $1.5 billion in a Automobile manufacturing company’s debt recovery litigation because a form was improperly completed, because of a sloppy contract. Words matter.
- Picking the wrong venue or no venue at all
It’s important to think through which dispute resolution mechanism you’re going to use if things go bad with a contract. But that’s not the last step. Each contract should specify not just how you want to resolve your disputes, but where. This shouldn’t be too complicated. If you’re in Colorado, you should choose Colorado as your venue for dispute resolutions. If you and your counterparty are on the other side of the world, consider allowing a mechanism for remote or virtual mediation or another means of resolution that doesn’t require you (or your counterparty) to physically travel to the other side of the world.
- Ignore The Law
You can write the tightest, most precise contract in the world. But, ignore the law and you’ve got a worthless — even dangerous — piece of paper.
Franchisors get slammed when their franchise agreements don’t comply with requirements that vary from state to state. They may have to refund fees, pay fines and even stop doing business in certain states. Entrepreneurs raising startup cash get in even worse trouble when they don’t provide required disclosures and notices. The government can shut down their companies and bar them from serving as an officer or director of any public company. Every business faces its own set of legal requirements. If you ignore them, you could end up with anything from an unenforceable contract, to fines and even a staycation with an ankle monitor.
- No consideration or inaccurate consideration
As we mentioned earlier, the difference between a contract and a promise is that a contract is enforceable. What’s the thing that separates a contract from a promise? Consideration: It’s the thing you give in exchange for what you get in a contract. It doesn’t have to be much, but it has to be something, or there’s no contract.
The scenario where I’ve seen this come up with startups most often is with early consideration for IP assignment agreements. Each startup must own its own IP. And each startup founder must receive something in exchange for the IP that they’re giving to the Company. But in the early stages where a founder might not be getting paid, it isn’t always clear what this is. Is the founder getting equity? Then make that the consideration for the IP transferred to the company. But make sure you do it at the beginning and make sure you write it down.
If the founder isn’t getting paid and he or she isn’t getting equity, well, then you may have a problem. This is why, from a fairness perspective and from a legal perspective, you provide some compensation for every person who contributes to your startup. Because if you don’t, you may not own your startup.
- Can the contract be assigned ?
The most common successful exit for startups is an acquisition from another company. And if you’re a startup, you need to have this in mind every time you enter into a contract from the day you start up. When an acquirer looks to acquire, one of the most important things they’ll consider is whether they’ll retain your current contracts and business relationships you had prior to acquisition.
Contracts are all over the place in whether they can or cannot be assigned. But when you’re a startup, if an acquisition is the goal, you’ll want to make explicit that every contract you enter into can be assigned in the event of a merger, sale, or purchase of all the assets of the company. Otherwise, you may find that you were your own worst enemy in negotiating a potential acquisition of your company. Avoid the nasty consequences. Pitch those vintage. Instead, turn a liability into an asset. Create a well-prepared, up-to-date agreement that protects your business without trashing someone else’s.
