During the flurry of activity of starting your business, you may not realize the full extent of agreements that control virtually every aspect of your operations. Once you recognize that just about any agreement between you and other parties is probably some form of contract, you will better understand how your words can help … or hurt.
Some Common Types of Contracts
Think of your business as the hub of a wheel, with each spoke representing some form of contractual relationship. You may not fully realize the scope of contracts that your business might enter into — or how quickly those contracts are formed. The following are some of the most-common types of contracts that you are likely to see:
Even prospective partners that somehow manage to agree on every conceivable detail of co-owning a business still need a detailed contract. Without a written agreement on absolutely all partnership terms, don’t plan to see your business grow to maturity. Just one dispute between partners can take your company to its knees (or to its early grave).
At the very least, your agreement should define the following:
- Distribution of profits and losses among partners
- The role each partner plays in the company
- Voting rights of each member
- How and when partners can leave the business
- Requirements for bringing in new partners
But, if you want a really good idea of the contract provisions that your business needs to consider, take a look at the Uniform Partnership Act (UPA). In a mere 166 pages, this Act defines the partnership provisions set forth in all 50 states in the U.S. If you don’t define your own provisions, the rules within the UPA automatically apply. All partnerships, from LLCs to LPs, need a well thought out partnership agreement.
Employment and independent contractor agreements
Even one-person operations need help from time to time, generally in two forms:
- Full- or part-time employees, with payment reported on W-2 forms for tax purposes, or
- Independent contractors who perform services on an as-needed basis, with payment reported on 1099 forms at tax time
As the name implies, independent contractors work under terms driven by contracts. The nature of the work drives the extent of the terms, but you can expect stipulations that describe the work, payment amount and timing — and all definitions that make it clear that the relationship is not one of employment, which is very important in helping to prove that you have no tax withholding, workers’ compensation or other legal obligations. Either the hiring business or the contractor may provide the contract language, as long as both parties sign it.
With full-or part-time (W2) employees you form another type of contractual relationship. It might begin with an offer letter that can potentially create a type of contract even before they come on board. Certainly the employment agreement, which details payment and other compensation terms, job responsibilities, hours worked and more is an enforceable contract.
When the employment relationship ends, separation agreements formally terminate employment while spelling out what will happen in terms of compensation issues, ranging from severance pay (if applicable), unused vacation time pay, insurance options and much more.
If allowed by state law, non-compete agreements can protect your company by stopping employees from taking company-specific knowledge to future employment with competitors. But, the terms must have time limits, and they must be reasonable enough to ensure that employees retain employment opportunities. And, of course, non-disclosure agreements serve a similar purpose from a very different angle.
Keep in mind that many aspects of employment are governed by state and federal law. Flout those laws, and you could face government wrath — or at least an employee lawsuit.
Vendor and client agreements
Even the bill of sale that you receive after a shopping trip is a type of contract that typically grants buyers the right to expect a specific product or service in exchange for payment. Any type of agreement between vendor and client is a contract as well. This includes project proposals, estimates and more. Whether you are the vendor or the client, you typically have certain enforceable rights.
And a host of others
The list goes on. Take out a business loan, and you’ll sign a contract. Bring in a venture capitalist, and you probably have a financial agreement in addition to a possible partnership agreement if the investor obtains equity in your business. Buy or lease a building, and you’ll enter into l purchase or lease agreements, along with the policies that provide insurance protection.
Similarly, buying or selling an existing business often includes more than just the exchange of cash for assets, particularly if the seller wants to retain some degree of interest after the sale.
Even lawsuits that arise from disputes can create contracts. Since most people prefer to avoid the stress and expense of going to court, the aggrieved party might agree not to sue for some time period or perpetually by creating a covenant not to sue. In other cases, disputing parties might choose to negotiate settlement agreements out of court.
If It’s in Writing (or Not), It Could be a Contract
Virtually anything that you express in writing might be viewed by another party as a formal contract. The good news is that many breaches of contracts do not automatically send you into a courtroom battle. Most businesses prefer to resolve their disputes informally by correcting the issue at hand. But, when big money or major issues are involved — or when the parties cannot reach agreement — a formal lawsuit may be the best way for the allegedly-harmed party to pursue justice.
Contrary to common perception, don’t discount the possibility that an unwritten agreement can be legally binding. Depending on the laws (and a degree of judicial discretion) within any given state, verbal or handshake agreements are also enforceable.
In fact, according to one article in National Law Review, your actions can form a contract even without words or handshakes You’ll probably have to take these cases to court, and leave it to a judge to decide if the actions had all valid elements needed to create a legally-binding contract. You can avoid uncertainty simply by putting it in writing.
There is More Than One Way to Get Legal Support for Contracts
It’s almost never too early to seek advice from a good business and commercial law attorney, even when your business is at the planning stage. Still, you can often reduce legal costs by starting with customizable legal forms offered by companies like LegalZoom and other reputable legal service companies. Just make sure that you use forms based on the laws of your state. And, before signing on the dotted line, take advantage of document review services to make sure that the contract properly meets your business’ unique needs.