startup legal FAQ – 3-5. What up with all the contracts?

So what’s with all the contracts?

There is no truer maxim in the law than “get it in writing.”

Probably the single most effective service lawyers provide to manage risk is the thoughtful structuring, negotiating, and drafting of effective contracts. With very few exceptions, every transaction in which a company engages should be governed by a written contract. Without the correct agreement in hand, you should never take money from investors, hire employees or independent contractors, purchase intellectual property, or let anyone see your confidential information, to name just a few.

Here’s why:

  1. During negotiations, a written contract helps reconcile assumptions. People naturally, often subconsciously, make self-interested assumptions, but rarely give voice to them.  “Handshake deals” almost always blow up at the point when inharmonious or unrealistic assumptions eventually come to light. A contract requires a meeting of the minds. There is no better way to confirm that minds have met than to put the deal terms on paper and get everyone to sign off.
  2. A written contract is the best evidence of a deal’s terms. Without a written contract, the understanding of a deal resides only in the respective heads of the people negotiating it. What happens if they’re not around?  If you get sued over an oral agreement, since you won’t be able to produce a written contract you’ll have to convince the court that your recollection of the deal terms is the correct one. Good luck with that.

  3. And perhaps most importantly,

  4. The law dictates that some agreements must be in writing. Certain deals, such as work-for-hire agreements with outside contractors, for example, must be in writing to be enforced.

Why are contracts so long and boring?

A written agreement must be competent to govern the deal it is used for. In a transaction of any complexity, the agreement serves as a recipe for the deal, a complete instruction set for the parties to follow to carry out their obligations. It is also an error trap, a set of contingencies for what happens when a party does not carry out their obligations or when assumptions underlying the deal change.

Written agreements tend to grow in size in proportion to the value of the deal. A $200 purchase of, say, an office chair can be governed by a single page of contract language, primarily because no one is going to sue on it; if the other side breaches, it may be painful to lose $200, but that pain is rarely worth the expense of litigation. On the other hand, a $2 million agreement may very well demand as much as 30 or 40 pages of language to be competent. That kind of loss is worth suing over, so the agreement requires language to make it crystal clear for the judge, jury and opposing counsel to determine when a breach has occurred and who is owed what.

Thirty or 40 pages!?  Do you get paid by the pound?

It gets worse.  Sometimes a contract can get so complex that we’ll encourage you to agree on another document first – a term sheet that outlines the deal terms – before drafting or reviewing an actual contract.  A term sheet is a very effective negotiating tool that helps you ensure you’re reasonably close to mutual agreement on the major terms before getting bogged down in the minutiae of the language of the written contract.

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