The handshake is the ultimate symbol of an agreement — but a handshake doesn’t stand up in the court of law. In fact, a handshake will almost certainly fall through as soon as you start to lean on it to get what you agreed upon.
So, when you begin a business venture, you don’t need to practice your handshake; you need to study the contract process. Contracts are vital for almost every relationship you develop as a business owner: for suppliers and service providers, for employees and contract workers, for partners and funders and more. Contracts spell out what the relationship entails, specifically what each party must do and what they will receive, so there are no surprises and everyone benefits.
You know the basic task of creating a contract — signing on the dotted line — but if you don’t know anything else about the contract process, you need this guide to startup contracts.
What Is a Contract?
If you shake hands over a verbal agreement, is that a contract? If you and another party sign a statement on a cocktail napkin, is that a contract? A definition might seem like an unnecessarily basic place to start, but too many would-be entrepreneurs simply don’t have a firm understanding of what counts as a contract.
A contract is not just an agreement, but it is a legally binding agreement. That means if one party doesn’t adequately uphold their end of the bargain, the other party can pursue compensation through the court of law. To be legally binding, a contract must have:
- A legal purpose. This is to say that you can’t create a contract that requires a crime. Contracts for murder, theft, fraud or other illegal actions are not enforceable.
- Mutual agreement. You shouldn’t sign a contract if you don’t agree with the terms, and you can’t force another party to do that, either.
- Consideration. This means that both parties must give up something in exchange for a benefit. The thing you give up might be time, service, products or money.
- Competency. Minors, the mentally ill and those under the influence of drugs or alcohol cannot form contracts.
The Contracting Process
Contracts do not magically appear, and they are not fulfilled with a snap of the fingers. The contract process is a long and complex one, and any misstep at any stage could result in wasted time and resources — if not a total collapse of the potential relationship forged. That’s why most small businesses take advantage of contract management software from Exari; digital tools like these make it easier to understand what contracts are saying, what deadlines are looming and what you can do to ensure every party emerges with benefits.
Even with contract tools providing assistance, it’s imperative that you understand the seven steps of contract management, which include:
- Preparation. This is when you identify your needs, establish your goals, define your risks and set your expectations for the contract.
- Creation. You (or another party) will draft the initial document outlining what both parties want and what consequences will occur should one party fail.
- Negotiation. Likely, the document will be passed amongst parties until a final consensus is reached.
- Approval. This is the handshake, the signing and the celebrating.
- Tracking and execution. Ideally, your contract management tools will calculate deadlines and break down tasks, so you can stay on track.
- Analysis. After the contract has been executed, it is wise to pull it apart to understand just how much you benefited — and whether you should renew the terms again.
- Storage. It’s a good idea to hold onto contracts and related documents (even if you don’t renew them) for at least three years.
Types of Contracts for Startups
While these are the basic elements of all contracts, as a startup entrepreneur, it’s likely you’ll only encounter a handful of contract types. Specifically, you should do a deeper dive on:
- Business formation contracts. These will explain the agreements made amongst owners, which form the basis for your business.
- Intellectual property and NDAs. IP is more important than ever, especially if your startup is involved in tech.
- Employment and contractor law. You need to know the difference between different types of employees before you can draft the appropriate paperwork for their hire.
You can base your business on a couple handshakes, but you will likely be taking on more risk than your startup can survive. It’s far better to do your due-diligence on contract law, so you can form a strong foundation from which to grow.