Our team was on a call recently to help negotiate a deal between two companies as I was reminded of the importance of contracts. Specifically, of the importance of business leaders having a firm understanding of contract terms and attorneys possessing a business perspective. Over the years, I have worked with attorneys who had a keen business sense (said things like “If this is what it will take to get this deal done, we can leave that clause out”) as well as those who didn’t. Attorneys, like all of us, have disparate mindsets and experiences that impact their judgment in any situation. All of them, however, work for their clients to reduce the amount of risk to zero (or close to it). That’s a good thing, but sometimes the process to do so overly-complicates matters and can put a deal at risk.
The point is that all business leaders and entrepreneurs need to have some knowledge of what is contained in their contracts. This will help in negotiating favorable deal terms, speeding up the contract process, and ultimately lower their legal costs (or so you would hope).
There are many components to a contract, but the section below highlights a few notable components.
Five Important Components of a Contract
- Deal Terms & Structure: This is arguably the most critical section and will ultimately drive how successful and profitable a deal is. That said, it is important to get creative when it comes to deal terms. Consider thresholds and “kickers” to help motivate performance on behalf of your partner as well as increase the profitability of a successful deal. Base financial incentives on metrics that are outside of the norm. The point is to be creative as there really is no right or standard set of deal terms.
- Beware of the Long Tail: In many cases, we have seen a “long tail” inserted into an exclusivity or payment clause. This is not necessarily a bad thing, and often will provide a critical level of protection, but is something of which to be aware. Be sure to ask your attorney about this.
- Narrowing the Exclusivity: Often times, partners would like to prevent you from working with anyone they would consider a “competitor.” Be sure to look at the exclusivity list and try to tease out those that are truly competitors and seek to remove the rest. This will go a long way towards reducing impediments to your company’s future growth.
- Term and Termination: Be sure to gain a firm understanding of the contract term and ability of either party to terminate. Even a diligent business leader or entrepreneur may not realize that there is an auto-renewal clause embedded in the contract that extends an agreement beyond the initial term. This is fairly easy to discern from a contract, but important to consider. As a practical matter, it may be helpful to set calendar reminders to remind you to either extend or terminate an agreement.
- Dispute Resolution and Arbitration: This is an interesting one and a section we’ll leave to your attorneys. The idea is that arbitration can often be a better method of resolving a dispute than litigation. Consider this as a key component to consider in your contracts.
Contracts are indeed quite complicated and require legal support and guidance. That said, they are not merely the domain of your legal team and require the attention of executives within your firm. Study up a bit on contracts and ask your attorney to explain some of the more common contract sections.