The question I am often asked is whether a contract is even necessary. I can tow the line and give you the typical lawyer response; that they are necessary and you should always hire a lawyer to write it for you. But I’ll let you in on a secret: it’s all about contract risk management. Preparing a contract is like insurance. You can both under or over insure yourself, and the appropriate level depends entirely on your unique situation. In other words, there is a time and place for skipping the contract, and for finding the absolute best law firm around to write your contract.
For a new startup or a small business, the cost to write a contract is expensive. The closest thing I have to an exact dollar figure is $6,900. That’s the cost to review the average business contract in 2018 according to World Commerce and Contracting. I think it’s safe to say writing one today in 2022 is more expensive. It’s not surprising, therefore, that lots of businesses skip the contract and do transactions by handshake or a short invoice.
Why write a contract at all?
Before I get further, let’s build on this question. I hear this additional context given all the time: I’m just selling homemade cakes and it’s not a million dollar business; can’t I just skip the contract?
You can certainly conduct your business however you want, but you should think about the risk. Baking cakes at home as a side gig might be a simple transaction and maybe not extremely lucrative, but you can still rack up significant losses. Somebody could get sick, or more likely, somebody could forget to pay. Maybe they aren’t happy with the texture of the cake and want a refund. I think it’s worthwhile to think those through and be able to tell a client up front what your policy is on damages, refunds, returns, late fees, etc.
The key point here is that a contract is just the agreement between parties. We’ve all heard of oral contracts, so these terms don’t have to be on paper, filled with legalese. Remember the purpose of the contract is to let both sides know the details of the transaction, outline the roles and responsibilities, and to put in solutions for a few hypothetical situations. All of these are to facilitate the transaction and to try and get a speedy resolution in case of any event. Once again, it’s contract risk management. And because it’s contract risk management, there is no right answer. Maybe you’re always comfortable with refunds, or maybe they are sold as-is. Are you prepared to lose your house in the transaction, or do you need to set a limit to your liabilities?
DIY is a legitimate option!
Legal documents have gained an aura of mysticism, and I can understand when entrepreneurs don’t want to touch a legal document. If you aren’t comfortable with DIY, don’t do it. In my view (and I’m obviously biased), it is a document like any other. If you read a well-written contract carefully, you should be able to understand it. If you want to draft a contract, use words you understand, and write it out in plain English.
A contract you write on your own with no help is usually just as binding as one drafted by a lawyer. Don’t get me wrong, you can make mistakes or put in something dumb, but there is nothing inherently wrong with a do-it-yourself approach. Naturally, there is a spectrum of options you can choose from, ranging from literally nothing to a room filled with the country’s top legal minds. While the mental image of a contract might be intimidating, it doesn’t have to be a thick document. Even a one-pager could be stave off the worst of your risks. For example, a simple invoice with no legal terms will at least make it clear to both parties the products you’re selling and the price. That’s the lion’s share of business disputes right there. Then you work your way up through the next most likely or damaging risks. For example, late payments or defective products. You eventually get to the laughably unlikely scenarios; what do we do in case of alien invasion?
Your superpower: business acumen
A lawyer’s job is not to make contracts hard to read. It’s to use their experience to put in a provisions to safeguard your end of the transaction. I’d argue that you, the business owner, can hold your own against an external lawyer’s ability to judge the risks in your transaction. They may have some experience in your industry, but more often than not, they are just putting in a few sections regular folks don’t tend to think about. Take limitations of liabilities section for example, it basically says regardless of what happens, both sides agree to limit the damages, claims, etc. to a fixed dollar amount. If I open a cake shop, I might say, regardless of what happens, that cap is $1,000. Even if you get seriously sick, I’m only liable for $1,000 (with a few common exceptions like willful misconduct and gross negligence).
Something is better than nothing
Don’t sweat over this. In my opinion, you are almost always better off having something in your contract rather than nothing. You understand your business better than an external lawyer can, and you know what risks you face. Address them in plain English, and you will be better off for it. If you are worried about the tricks of the trade, look at another contract. Google them. Use standard templates. There are really only a handful of these sections that are missed by this approach, and they are: confidentiality, indemnities, limitations of liabilities, and term and termination. Once you understand the risks those sections are meant to address, you can write them in yourself.
The way I see it, if you had limitless resources, you’d want to hire a lawyer and work with them closely so you get the benefit of both their legal expertise and your own business savvy. But the old adage is “don’t let perfection be the enemy of good”. Just because a DIY contract is inferior, it doesn’t mean it’s bad and shouldn’t be done. You can mitigate or even remove some common, obvious risks at very low costs. It’s like sticking a “no refunds” sign in front of the till. It’s a real solution to a problem. Don’t let a lawyer shame you into skipping the obvious.
What is optimal?
As you can tell, I highly recommend some document, anything at all. You need to manage the contract risk. The handshake or verbal agreement doesn’t tend to work well. The act of putting a transaction in writing itself is significant. It clarifies the details. It ensures both parties are on the same page. And they’re both putting it in writing. It just creates evidence and a paper trail should something go wrong later.
Once you get past that hump, each dollar is diminishing in value. You are dealing with more and more remote possibilities and risks. You want to deal with risks that are highly likely to occur and/or highly impactful to your business. If you own that cake shop, you don’t need a novel to deal with those risks. You can conceivably fit the risks all in a one-pager. On the other hand, if you are creating electronics worth millions of dollars, you’re going to want something more substantial. Even if I know the size of your business, your risk tolerance and appetite will further dictate what legal services you need. The only thing I can add is that, like insurance, legal services are often under used. Whatever you think is necessary, you likely need just a little bit more. People tend to be optimistic!