In my fifteen years of helping small businesses, the most common question I hear from budding business owners is, “What kind of legal agreements do I need?” As a good lawyer, I used to answer with the response entrepreneurs hate most: “It depends!” When pressed for a list of the most common, or most important, there are three main agreement categories almost all businesses can benefit from.
When starting a business, it doesn’t matter if you are a corporation, LLC, or partnership. If you are in business with another person, you need a written agreement with all co-owners. These can be:
• Operating agreement
• Shareholders’ agreement
• Founders’ agreement
• Partnership agreement
All share a similar function, which is to ensure the deal between co-founders is set in stone so everyone can focus on building the business. A good agreement outlines ownership percentages, capital contributions and disbursements/salaries. It also acts as the company “prenup,” detailing what will happen to the business if you decide to part ways.
Several years ago, I mentioned this to a distant friend when he was starting up a new company. He noted he didn’t want to spend the money on a shareholder agreement and believed all the business partners were on the same page. Unfortunately, one wasn’t, and a few years later he was over $40,000 into litigation with one of his former partners. He paid a huge price in the end for not having an owner agreement and eventually folded his businesses when the legal bills became too much.
Remember, if you fail to implement a formal agreement, there can be costly consequences in the end. Be sure to put it in writing and save the hassle down the road.
If you don’t have employees, you might be skeptical, but this agreement includes independent contractors as well. These are the people designing your website, managing your database, or performing your legal and accounting work. Even if they are not your full-time employees, they are still working for you and you need to have the terms of the deal fully fleshed out before work commences.
Numerous times I’ve seen over-anxious business owners hire a designer or development company without a formal agreement, then came to me upset noting they didn’t perform to the right standards, were taking too long, or even worse – they took the money and did nothing. Without an agreement, you might win a court battle, but not without spending a lot of money and time.
To alleviate this risk, I advise every entrepreneur to have a form independent contractor agreement, one with a single exhibit that sets out the duties, timing, payment and other details specific to the engagement. Also, have a form employee agreement you can use to ensure your employees have agreed to provisions like assignment of inventions, confidentiality, and non-solicitation.
Outside of not having real legal documentation, one of the biggest problems I’ve seen in this area is a business owner that treats a contractor like an employee. If you are controlling hours and job duties, and giving them work space and equipment, you need to check with counsel if you really have an employee. The penalties can be stiff for improper classification, including back pay, benefits, vacation and even tax and withholding problems.
Customer and Vendor/Supplier Agreements
When starting and growing a business, customers are the all-important source of revenue, with the vendors and suppliers used to fulfill customer demand next in line. Every time you make a sale, you have contracted with your customer, and that contract needs to be designed to help frame the relationship with them and provide all parties with the legal protections bargained for. In e-commerce, these contracts are generally “click-wrap” agreements like terms of service and privacy policies that set the service level and expectations for the consumer.
For vendors and suppliers, you must have a way to ensure that your needs are met – and by proxy, the needs of your customers. Terms like indemnification, exclusivity and limitations of liability all need to be carefully drafted to make legal and business sense.
In general, the agreements outlined above are a really great place to start to ensure you and your business are protected. Be sure to put these agreements in place early to mitigate any future legal risk.