The Most Important Reason to Create a Business Contract

Relational Attorneys:

Attorneys who do the type of work I do – forming companies, raising capital, mergers & acquisitions, etc. – are sometimes called “transactional” lawyers. The idea is that we work on transactions that have a beginning and an ending. This is as opposed to, for example, compliance lawyers who often provide ongoing advice and services to heavily-regulated business clients.

Transactions, such as a merger or acquisition, are one-time events. At least, they are for the attorneys and other advisors involved. Our clients, on the other hand, are just embarking on a long-term relationship. While some mergers or acquisitions involve layoffs and severe cost-cutting, others are more strategic and growth-oriented, and in those cases the outcome of the deal is often a much larger company, with all the employees now rowing in the same direction toward a new, shared goal. This is always the case with joint ventures. “Joint venture” is a term used to describe a type of partnership between two or more companies who come together for a specific purpose – to enter into a new market or launch a new product, generally using some people or resources from each participating company.

Once the Transaction is Over, the Relationship is Just Starting:

While my work may be complete when the acquisition agreement or joint venture documents are signed, my client is just getting the party started. In this context, just about the worst thing I can do is apply an “us vs. them” approach that polarizes the parties, rather than brings them together. Yes, I have my client’s back, I want them to get the best deal they can and I absolutely want to be sure they don’t wind up in a bad contractual situation. However, when my client wants to get a deal done, I should want to get that deal done. That doesn’t mean I don’t talk about possible risks, because I do. It means, though, that I am there to facilitate, not impede, the deal. And, I want to get deals done on favorable terms at the closing table, while also ensuring my client and the company on the other side of the table feel good about moving forward together. After closing, they need to start actually working together. That makes the closing time the starting gate, not the finish line.

Great Communication Among Startup Founders:

When I counsel startups we spend a lot of time talking about their goals and expectations and what they all want out of the venture. When partnerships break down, it is typically because the partners have not been communicating well, or at all. Great business communication starts right out of the gate, at the time the founders are launching the business. How many hours do we each expect to work? What will we each do? How will we make decisions? How will we resolve disagreements? Why are we even doing this?

That last question is an interesting one. A founder who wants to change the world is very differently-motivated than a founder who wants to change their world by making a ton of money. Having those open, candid conversations is invaluable. Even if the founders aren’t perfectly aligned, understanding and appreciating where they are each coming from makes a world of difference. Perfect alignment may not always be possible, but perfect understanding is not.

Most of my clients start out believing that the number one reason to create a contract, such as a founders’ agreement (this agreement trades under different names), is to have a strong contract in place for enforcement purposes in case they later wind up in a dispute. And, while that is one reason to hire a lawyer to create a contract, in my opinion it’s the third most important reason in almost every business context, including with startup founder agreements.

The Most Important Reason to Create a Business Contract:

The most important reason to create most business contracts, including a startup founders’ agreement (this may be called a Shareholders Agreement, an Operating Agreement or something else depending on the type of entity), is to be absolutely certain the founders talk through all the important considerations about how their partnership will work. Just like with a marriage, everything may be rosy now and the participants may be constitutionally incapable of even envisioning a world where they disagree. However, it is almost inevitable that there will be some rocky patches. Talking through important issues and considering various situations that may later arise might lead founders to decide working together is not the right thing to do. More commonly (because they are usually dead set on moving forward together), it helps them forge common ground and a shared understanding about how things should work for them. It gets them in sync. The second most important reason to create the contract is to document that shared understanding. We all have selective memory. Yes, you, too.

Back to the third reason – having a strong contract to enforce. If you wind up needing the contract for that purpose, you have lost big-time. Litigation is, at best, a zero sum game. Often times, it’s worse than that. Sure, there are legitimate differences of opinion, misunderstandings, different takes on interpreting an agreement and making decisions about the “right” thing to do in a startup or any company. But, 90%+ of disputes I see suffer from a lack of communication. The dispute kicks in, the parties cling to the contract, they hire expensive litigators and they fight. What they ought to do is sit down together and deconstruct where things went wrong.

Instead of “transactional” attorney, I might start using the term, “relational” attorney.

I’d be happy to help with this story / provide a quote or two. I am not entirely sure, simply based on the title, where you are headed. I have been writing quite a bit recently (for a book I’m aiming to get out in the next six months) about the need for a formal contract at all if the underlying relationship is very strong. I believe a written contract in any relationship context (i.e., where the parties are going to have an ongoing relationship, as opposed to one-time transaction, e.g., sale of a car) is most important for these three reasons:

1) to ensure the parties talk through all the important points;

2) to ensure the parties are in agreement on all the important points; and

3) to ensure no one “misremembers” the deal.

The first two points don’t require a written, formal contract. A formal contract facilitates what is needed – thorough discussion and agreement. The third point can be covered well in a clear email. Lawyers tend to pitch other reasons for formal contracts, e.g., the ability to enforce the contract. That’s rarely a factor unless the relationship breaks down through a lack of communication or where one of the parties is slippery, in which case a formal contract becomes tough to enforce anyway. Slippery parties are tough business partners. Some lie, finagle and litigate for fun – there’s that certain type of person with whom the contract won’t help anyway, they will just ignore it. That’s much more common in small business world than public company world, although it’s a very real thing. In other words, with almost every person/company you’d want to get into business with, lawsuits only come up when the relationship was not handled properly and, in that case, a formal, written contract doesn’t prevent the problems. Frankly, a formal contract may hinder resolution of the underlying issues because the business people rely on the contract and throw things back over to the lawyers when they actually don’t have a legal problem, they have a relationship problem. In the absence of a formal contract, lawyers would basically force their clients to work things out because you don’t generally want to go into litigation without a formal contract, i.e., a formal contract encourages litigation as much, or more, than it prevents it, IMO).

What Next:

Whether you need to create a business contract or you are reviewing one you have been asked to sign, I can help. Understanding your rights and obligations is one step in the contract process. The other is understanding how to best approach the relationship to achieve what you want. My experience launching companies, managing people and working with startup founders offers a unique and broad perspective on contract law and the relationships aspects of business. Get in touch with me and let’s talk about your unique situation.

Author: Brett Cenkus

Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a variety of businesses and has clients throughout Texas as well as many technology clients throughout the United States. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial heart. As a founder of 6 companies himself, he is especially passionate about helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood’s Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. You can learn more about Brett by visiting the About page on this website.