Startup Tips: Be Wary of Form Contracts
Updated: Jul 20, 2019
I’m frequently asked to review contracts sent to a startup by a counterparty. I’ve learned not to be surprised when I see a clear indication that the contract was not prepared for that specific business relationship. Some contracts contain the names of the wrong parties, others have a conspicuous watermark on the document, and some contain terms that make absolutely no sense in the context of the agreement. These issues typically arise in one of two scenarios.
In the first scenario, the contract is an online template. The steps leading to the outcome are easy to imagine: the scrappy startup, do-it-yourselfer runs an online search for a contract s/he thinks is appropriate for the agreement, finds a sample template, downloads or screenshots the template, and then uses the template as is. In many cases, the templates are overlaid with a watermark, or have online company’s name inlaid with the text.
In the second scenario, the contract is borrowed from a colleague or peer company. The steps are similarly straightforward: a founder asks colleagues in his/her startup community whether they've entered into a similar agreement and, if so, that they shoot that contract over. Often, the founder gives a less-than-thorough proofread, leaving obvious incongruities.
Both tactics suffer from the same two problems: (1) the terms weren't meant for that situation and (2) there is a risk of looking unprofessional.
Including the Wrong Contractual Provisions. Although most contracts typically follow a similar format, they are incredibly bespoke documents. Online templates are generic and designed to be customized only after purchase or logging in. Failing to take these extra steps can unnecessarily leave a startup exposed to unwanted legal liabilities or obligations. Contracts that were used by a peer company were likely customized for that company’s particular agreement:
The terms of a borrowed contract could be specific to that deal;
The startup in the new deal may be exposed to legal risks that the original company wasn’t; and/or
Worse, the terms may have been bad for the peer company but its counterparty insisted upon those terms—if the startup uses those same terms, it will be at a disadvantage before negotiations even begin.
Sending the Wrong Signals. No one wants to start a new relationship on the wrong foot. A document with a "sample" or "template" watermark or the markings of an online, legal-services provider signals to the counterparty that the startup doesn’t know what it’s doing and can be taken advantage of. A document with the names of the wrong parties is sloppy, unprofessional, and signals that the startup doesn’t respect the counterparty.
This isn't to knock form contracts or using precedent from colleagues. Form contracts are useful and can save a lot of time and money, but only when they are properly utilized.
If you use an online form contract, do it correctly. Spend the money—typically a small amount—to gain legitimate access to the document and all of the customization options that the website provides. Go through the customization options. And think about the terms you want to include, as well as the terms you want to exclude.
If you borrow an agreement, do your homework. Get as much information as you can: Ask your colleague for background on the key terms, how the relationship has played out, and if there’s anything s/he would change. Then read through the agreement yourself and think about how each term could be beneficial or harmful to your current and future goals. Also think about the agreement more generally: is something missing that you think ought to be included?
If you’re not comfortable doing this yourself, ask a lawyer. This doesn't need to be an expensive engagement, and your lawyer should not re-invent the wheel. To avoid over-billing, send a copy of your draft with a set of very particular questions. Without needing to bill many hours, the lawyer should be able to identify some contract modifications to your benefit. The lawyer may also have (or be able to draft) a better form contract that you could use for the current agreement, and other agreements going forward.
Do you have questions about a contract you've been asked to sign? Don't hesitate give us a call, or reach out to firstname.lastname@example.org.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.