Contracts are something of a necessary evil. In a perfect world, a start-up would never have to worry about consulting agreements, NDAs, or other contracts. But tech business owners need to know how to use contracts to protect their business.
We asked Suzie Dingwall Williams, partner at Venture Law Associates, if in her 20 years of tech experience, she has seen startups fail because they didn't have the right contracts in place. Her response: "All the time. Especially when it comes to contracts among the business founders and contracts with first customers."
When you're in the startup phase of your new business, your company is at its most vulnerable. Let's take a closer look at the type of contracts that can help you reduce that vulnerability.
The Mess IT Companies Can Get Into Without the Right Contracts
Peter Moldave, attorney at Gesmer Updegrove LLP (@GesmerUpdegrove) echoed Williams' caution and offered an example of a contract issue that threatened a tech startup.
"A cofounder decided to return to graduate school, but wanted to keep his equal share in the startup,” Moldave explains.
What would you do if 50 percent of your stock decides to leave the company to go back to school? Without the right contracts in place, ownership and equitable divisions can get messy.
In addition to problems with shareholders and cofounders, your business may face these contract-related issues:
- Banks and investors could offer less favorable lending terms if your company has inadequate or unfavorable contracts.
- Competitors could take your ideas if you don't protect your inventions and intellectual property.
- Cancelation fees could cripple your business if you have to leave an agreement early.
Williams explains that contracts limit liability to your customers. "If your first commercial implementation goes awry, you could find yourself forced to reimburse your customer an amount well in excess of the contract value," she adds.
Limiting your risk exposure to expensive lawsuits is a key reason to have stringent contracts in place.
4 Contracts Every Tech Startup Needs
IT consultants, like any business owner, can run into trouble. Williams offered this metaphor: "As any woman will tell you, a dinner date is not a relationship, and in business, a handshake is not a contract."
It's not enough to rely on another party's handshake and promises. We recommend using the following written contracts:
- Stockholder or partnership agreements. These contracts ensure founders and business partners are on the same page. They protect your company if someone leaves and set the terms of when another party can sell your shares.
- Non-disclosure agreements. Why are NDAs so common? Moldave explains that NDAs enable discussion of features of products and other sensitive information. In short, NDAs protect your ideas.
- Employment agreements. Moldave warns that employment agreements should not promise employees any long-term employment. They should make it clear that the employee is "at will" and either party can terminate employment when they choose.
- Service agreement / client contracts. You should sign a contract with your clients to outline what your services include, how you'll be paid, and who is liable for what. Your clients may want you to use their service agreement contract, pushing for terms that are more favorable for them and less favorable for you.
It's always important to talk with a lawyer to help you understand what's at stake if you sign a client contract and push back against any unfair demands.
How Does Insurance Fit in to All This?
Moldave encourages all his clients to obtain proper insurance, including Cyber Liability Insurance if they hold customer data. The reason: cost.
"The cost of a cyber-insurance claim can sink a small business," Moldave says. "Even just the expense and time in defending a claim can cause distraction."
Business owners that have insurance can afford professionals (e.g., attorneys and cyber incident investigators) to take these issues off their plate and focus on running the business.
IT companies may want different types of insurance depending on their data liabilities. If you have…
- First-party liabilities (i.e., if you store customer data on your own network or devices), Cyber Liability Insurance may cover the cost of security incidents.
- Third-party liabilities (i.e., you recommend software or solutions that handle personal data, but don't actually store this data on your systems), you can invest in Errors and Omissions Insurance to cover lawsuits when a client sues you over a security problem (or other tech issue) with a product or service you’ve recommended or provided.
Having the right contracts from day one is essential to avoiding potential disputes and miscommunications that can lead to lawsuits and squabbling within your company and with its clients. If you don't have the right agreements in place, you could cost your business big money and missed opportunities.
To get started, check out our free contract templates for IT business owners.