Contracts: Entrepreneurs, How Do You Know When You Need One?

How to Get More Sleep

Do you sometimes lay awake at night wondering what will happen if your biggest customer doesn’t pay you? How about if the vendor handling your website upgrade takes off with your two thousand dollar down payment? These scenarios would be a nightmare for any bootstrapping entrepreneur.

Contracts Can Make You Money

One of my clients who owns an internet-based consulting firm was hired to create a new website for a client a few months back. He received a $500 deposit for several thousands of dollars worth of work. Then he hired a web coder, with whom he had a good relationship, to handle certain aspects of the web design. He and the web coder completed the work and guess what happened next? The client stiffed him. And not only him, but also his web coder because he didn’t have the money to pay the web coder out of his own pocket. This caused a strain in the relationship between the consultant and his web coder and a major strain on his pockets.

Several months later, the consultant hired me and I used my magical lawyer ways to collect all of the money from the client. (Note: magical lawyer ways = calling the client, announcing that I am a lawyer and demanding payment. Okay, okay it was more complicated than that but, most importantly, it worked). He was happy to get fully paid and be able to pay his web coder but the strain on the relationship with the web coder could not be erased, he lost the time value of the money he was paid in January instead of the previous August, he spent a lot of time chasing this guy instead of working on other projects and he was out the attorney’s fees he had to spend to collect the money.

How would this scenario have been different if the consultant had a contract for his relationship with the client and the web coder? First of all, in his initial strategy session with me, I would have advised him that his payment collection method was not ideal and we would have set up a better payment system. Additionally, the client contract would have required the client to pay interest on late payments and court fees plus attorney’s fees if he wound up having to hire an attorney or take him to court (in a court specified in the contract) for breach. With such a contract the chances of getting an enforceable judgment (read: getting paid) are much higher and it may not cost you as much money since the contract stated that the client pays your lawyer’s fees. And even more importantly than all of that, when you show clients that you are professional and serious about your business (i.e., when you have a professional agreement in writing that they must sign in order to work with you), they will think twice before trying to stiff you.

Regarding his relationship with the web coder, a subcontractor agreement specifying that the web coder would get paid when the business owner gets paid by the client, could have eliminated the bad blood between the parties. Plus, there are a myriad of other things to include to set boundaries and make it clear to both parties what happens in various other scenarios that can come up.

Everyone is an Enemy!

I often tell my clients that “everyone is an enemy to your business!” Your business partners, customers, vendors, employees, etc. all have the ability to screw your business over. So you have to treat everyone (and I mean EVERYONE) like an enemy on paper. Only then are you free to treat them like a friend in person.

How do you do that? By having a well-drafted contract for every relationship your business enters into.

Rachel’s Rule of Thumb

Here’s my rule of thumb that will protect your business from all manner of headaches, financial loss, emotional distress and yes, lawsuits as well: Have a contract for every single relationship your business enters into. You and your buddy starting a new business? Create a contract that governs that relationship. Selling your new widgets in that new widget store up the street? Draft an agreement between you and the widget store owner. Setting up a website to advertise and/or sell your services? Have a privacy policy and/or terms and conditions to govern your relationship with people who check out your website.

These contracts do not have to be uber complicated but they do need to protect you from all (or at least most) of the ways the relationship can go wrong.

Once you have an agreement with your independent contractors, vendors, clients and business partners, you can go back to getting enough sleep at night because you know you’re well protected.

Have you ever been stiffed by a client or screwed over by a business partner? How did having a contract help you?

Photos courtesy of The Intrepid Traveler and Rie H.