Plenty of clients call me or come to my office to tell me that they have made an agreement with someone and they want for me to write it up in a proper contract. I prepare the contract, send it to the other party’s attorney, and then both parties are stunned by the cost to finalize the contract. As with anything, there are many ways to successfully negotiate a contract. You can certainly shake hands with someone and then have the lawyers haggle for you to finish an agreement.[1] You can write something on a napkin and it may be enforceable. These are my recommendations to help streamline the process of negotiating a contract and keep your legal fees down.[2]
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Know what constitutes a “contract”
A contract is a specific offer from one party to another, with acceptance and payment or performance by the recipient of the offer. For example:
Example #1: “Will you paint my house blue for $1000?” + “Yes” = Contract
Example #2: “I will paint your house blue for $1000?” + “Yes” = Contract
Example #3: “Will you paint my house blue for $1000?” + [Paints House] = Contract
Difficulties arise when you are in a more complicated agreement than painting a house blue. When the attorneys start working on the agreement, they are looking out for each of their clients’ interest in ways that the clients could not necessarily predict based on their own experiences. Attorneys read thousands of cases about contract disagreements and take from these cases the issues to avoid and the language to use in the contract so that a court will agree with their clients’ side if there should be a disagreement. That is why attorneys are important and valuable to their clients. For example:
“Will you invest money in my company for a percentage of the company’s ownership?” + “yes” = Contract… until the attorneys get involved.
Company Attorney Thinks: |
Investor Attorney Thinks: |
Both Attorneys think: |
| How do I maximize the investor’s responsibilities? | How do I minimize the investor’s responsibilities? | Must specifically define responsibilities |
| How do I minimize the company’s responsibilities? | How do I maximize the company’s responsibilities? | Must specifically define company responsibilities |
| How do I get the most use of this investor’s money and expertise? | How do I avoid letting the investor to become a personal piggy bank for the company? | Must specifically define amount of investment of money and time |
| How do I include the investor in our decisions and operations so he will be invested in our success? | How do I avoid letting the investor get dragged into insolvency or scandal by this company? | Must specifically define extent of investor involvement and company accountability |
| How do I get rid of this investor if he becomes a giant pain? | How do I keep the investor from being cut out of major decisions or profits? | Must specifically define investor voting, profit-sharing and buy-out rights |
| What can I do to save the company money and avoid bad publicity in the event of a future disagreement? | What can I do to save the investor money and avoid bad publicity in the event of a future disagreement? | Must specifically define conflict resolution procedure with a provision for prevailing party attorney’s fees |
How do you avoid the issue of having the lawyers haggle for hours over questions you did not consider?
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Work with your attorney to prepare a “term sheet”
Spending an hour or two with an attorney before you make an offer to enter an agreement with another party can save thousands in attorney’s fees during negotiation. Wikipedia says that “A term sheet is a bullet-point document outlining the material terms and conditions of a business agreement.” It is not binding, but it will allow the recipient of an offer from you to understand the basic legal terms of the agreement, going way beyond the understanding that an investor will be giving you money in exchange for a share of your business. Common contract terms that might be in a term sheet include:[3]
- Term or length of time for contract
- Termination of contract
- Manner of communication required for notice
- Manner of payment
- Indemnification
- Confidentiality
- Solicitation
- Non-disparagement
- Non-competition
- Forum and Venue for conflict resolution
- Attorney’s fees
- Miscellaneous provisions
Once you have decided on the terms you want to offer and discussed them with your attorney, the attorney will add all of the legal mumbo-jumbo to your term sheet. Then you can take the term sheet to the other party and haggle over that non-binding description of the terms of the agreement. When you say “yes” to the terms in the term sheet, it will be a theoretical yes, not a binding legal contract. This is good because you can negotiate without your lawyer present, and without risking getting into a binding contract that will make your attorney lose sleep at night. Urge your recipient to consult a lawyer regarding the term sheet, so that all of the risks and benefits are discussed over the terms in a general way before you start preparing the contract. After a term sheet has been signed, it guides legal counsel in the preparation of a proposed final agreement. If both parties have become comfortable with the term sheet, you may also be able to avoid a second round of negotiation between your attorney and the other party’s regarding the contract that would cost everyone a bundle.
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Back your attorney on the terms
Once you have a signed term sheet, the substance of the agreement has been finalized and the time is come to put it in final form. Negotiations should be over. The attorneys for both parties will talk about word choices and sentence structure to make the contract clear. However, if you find yourself in a negotiation over the contract terms at this point, do not give in to the pressure. Being too flexible at this point could make the opposing party think other matters are still up for discussion. A detail you think is minor can open the floodgates to a wave of tiny changes of wording and sentence structure that could worsen the terms of your agreement and cost you a lot of attorney’s fees. It is better to put your foot down and insist on the terms to which the parties already agreed in the term sheet. Giving your attorney the ability to stand firm, and to use her discretion on whether to make an adjustment is important to saving yourself time and money.
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Set a deadline to sign
If enough time passes to constitute a “reasonable time,” your offer can expire, but it is preferable to have a certain deadline. You should be able to conclude a contract, assuming you follow these recommendations, within 30-60 days. The more rigid your offer, the quicker the negotiation will go. “Take it or leave it” is a quick way to end a negotiation, although it may end with your losing a potential agreement.[4]
What is the difference between having a business lawyer draft my contracts.
What are some of the most common mistakes made by business owners with their contracts?
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