As a small business owner, you might have entered an agreement or started work based on good faith as opposed to a signed contract. But what if there is a disagreement over product delivery or an issue with a contractor?
Not having a legally binding contract leaves your business vulnerable and susceptible to hearing, “You’re being sued.” Small businesses stand to lose anywhere between $3,000-$150,000 in litigation alone. The cost of running a business without contracts is not only financial — the stress and emotional hardships faced can forever change the nature and well-being of your business.
Why Starting Work Before a Contract Is Signed Is a NO-NO
So how does a contract protect your business? It does so in multiple ways. Let’s look at a few ways contracts can protect and strengthen your business.
- Record of Proof and Commitment: Business contracts are a strategic tool that allow you to think ahead and pin down details regarding the scope of work, payment, confidentiality, termination, time line, etc. This signed document serves as legitimate proof of terms that both parties have mutually consented to.
- Minimizes Conflicts and Mitigates Risks: Most contracts go through a negotiation phase that ensures each party is getting a fair deal. This process is the foundation for a good working relationship as it minimizes chances for confusion or heated arguments later down the line. Each party knows what they should or shouldn’t do. And, if there are any discrepancies, there's a paper trail that you can refer back to.
- Provides Legal Security: Imagine having paid a contractor and they didn’t turn up or performed poorly? This financial loss has a significant impact on your business. Having a contract provides security because now, by law, each party is committed to its obligations; any breach of contract gives you the chance to take appropriate action. A contract also guarantees you get your hard-earned money for a job done.
- Elevates Brand Credibility and Authority: How can a signed contract add to your brand reputation and authority? First, it shows you are organized and knowledgeable. Second, it shows that you're serious about your commitment, which builds trust.
Critical Elements of a Contract
A study by the Small Business Administration reports at least 53 percent of small businesses are involved in a lawsuit at one point. Therefore, it’s best to have all your bases covered by creating bulletproof contracts from the get-go.
Here are a few key elements and hidden clauses in contracts you should watch out for to avoid a “gotcha” moment.
- Terms of Agreement: The Terms of Agreement are the building block of a contract and it should be specific between you and the other party. The contract should establish clear guidelines about the scope of work, payment, performance standards, termination and time lines. Don’t use a generic contract that you found online or assume terms.
Read all the fine print and watch out for statements that contradict each other, especially with terms like “notwithstanding” and “hereunder.” Such phrases can sometimes make certain clauses null and void, leaving you with the short end of the bargain. It’s best to have a professional lawyer review all the legal terms or aid you in drafting a contract. - Automatic Renewals and Financial Obligations: Popularly known as the evergreen cause, automatic renewal clauses can have money flowing out of your business even if you haven't used the service or thought it was over. These clauses are quite common in software and credit card services, so if you’re using either, pay extra attention to renewal terms. To avoid this financial strain, it's best to negotiate automatic renewal clauses or calendar the date a termination notice has to be sent.
Other financial obligations to watch out for include payment amount and schedule, damage liability and legal fees. Some contracts can require you to pay the other side's legal fees if there is a conflict. One way to protect yourself in such scenarios is by investing in business liability insurance. - Defined Path of Solving Mishaps: Contracts should stipulate a defined path for dispute resolutions. Will you try to settle amicably, go through an arbitration process or directly head to court? If it’s arbitration, then the contract should state the method of arbitration and whether the results will be held binding.
Another aspect to pay attention to concerning arbitration and litigation is jurisdiction, especially if the party is in a different location. Be wary of Venue or Forum Selection Clauses, which can lead you to litigate in a specific place that could be expensive and inconvenient. - International Contract Clauses: With globalization, it's likely you're working with international contractors or clients. Legal rights, jurisdiction, agreement terms and payment details are of even more significance now. For instance, some countries provide dealers protection if you, as a U.S. business, cancel a contract. In such cases, you could find yourself paying a prohibitively expensive amount. To avoid such surprises, it's best you consult an international business law expert before signing the dotted line.
- Last-Minute Revisions: Don’t fall into the trap of allowing numerous contract revisions — you’re more likely to miss something. A partner can alter ownership percentage or a contractor can change payment terms through these last-minute alterations. While it might be time-consuming and costly to review each draft with a lawyer, it will save you a lot of money and stress in the long run.
Important Contracts for Small Businesses
Now that we know how crucial contracts are and which hidden clauses to look out for, let’s discuss some of the most common contracts for small businesses.
Ownership/Partnership Agreement: Formulate a partnership agreement even if you are running a business with a friend or family member. This agreement includes details on a partner’s role, profit percentage and a contingency plan if a partner wants to split or passes away.
Employment Agreement: An employment agreement is one of the best ways to protect your business concerning any misunderstanding with an employee. It typically includes job title, responsibilities, payment and benefit terms and termination clauses.
Independent Contract Agreement: As a small business, you’ll likely be working with other businesses or vendors. A vendor contract can include rates, terms, project scope, deliverables, turnaround times and even liability clauses.
Always Get It in Writing
While running a business, unexpected things can always pop up. Signed contracts minimize risk, protect your assets and strengthen your working relationship. And, if by any chance, a matter does go to court, it ensures you have a strong case.
Seeking to get contracts in place for your business? Incfile’s Business Contract Library is the perfect place to start. The library has templates of several common small business contracts. Incfile's team can even help you write or review contracts that will keep your business protected.
Swara Ahluwalia
Swara Ahluwalia is a freelance content writer with experience in the technical, B2B and SaaS domain. She also has curated content for various lifestyle brands. In her downtime, you will most likely find Swara training for her next marathon or spending time with her two daughters.
