The Short Startup Contracts Guide
Don't sign another contract without knowing the basics.
Hey Founders et al. We’ve created a long list of legal “startup guides” to help founders navigate the stickier legal speed bumps that plague early stagers. Today, we are publishing our 3rd of this series: “The Short Startup Contracts Guide”. We’ve packed these guides with resources and organized them into actionable steps you can take (or earmark for later).
Previous Episodes
Coming Soon
The Short Startup Insurance Guide
The Short Startup Trademark Guide
The Short Startup Advisor Onboarding Checklist
The Short Startup Terms of Service Setup Guide
The Short Startup Fundraising Preparedness Guide
The Short Startup Data Privacy Guide
The Short Startup Data Security Guide
The Short Startup Employment Law Guide
… and more
so without further adeu…
Know your leverage. As a threshold matter, you need to understand what ability, if any, you have to negotiate terms. If the contract is for a small dollar value, or if the party you’re contracting with is a large multinational company with a very large volume of customers or users, they may be unwilling to negotiate terms or may be willing to consider a bullet point list of your issues but won’t accept a full markup of their contract or terms. For example, a software provider may not be willing to provide more reps and warranties or broader indemnities because their low contract pricing doesn’t allow them to do so for a large customer base. Understanding your leverage and the business risks and dynamics at play is the key to effectively and efficiently reviewing and negotiating contracts.
Do due diligence on the other party. If the other side is a vendor, make sure that you or a team member have checked out the vendor either through customer reference calls arranged by the vendor, or informally through your own contacts. This is especially important if the vendor is a newer, smaller, or less well-known company.
Issues to evaluate when you’re doing due diligence on the vendor include:
Quality: Does the vendor have a reputation and track record of offering a reliable, high-quality product or delivering quality services and/or deliverables?
Cost: Does the vendor offer good value for the cost? Do their customers often experience surprise costs or overruns, and if so why?
Capacity: Does the vendor have capacity to timely deliver the quality of product, service, or deliverable that you’re expecting? Do they use subcontractors and if so, what is the quality of their subs?
Start with a good template based on industry standards. There are certain contracts that you’ll end up entering into over and over again, especially those that you sign with your customers. While your leverage will influence whether or not your customer forces you to use their contract template, you’re usually better off avoiding it if you can. Their templates will often be very one-sided and may not be relevant for your particular product or service, exposing you to risk and delays as you and your attorney review and negotiate. If you adopt industry standard contracts, you can be more successful at starting the negotiations from a reasonable place, making the negotiation less adversarial, and closing deals faster. You can get free standard contracts from Common Paper, which leverages a committee of dozens of attorneys for drafting. A few examples you might use are the Mutual NDA, Cloud Service Agreement (sales agreement for cloud software), and Data Processing Agreement for GDPR compliance.
Check key contract terms. All contracts, even if they are low dollar value, involve financial and legal risk to your company. For example you could get locked into an expensive contract that auto-renews, or you could find yourself being sued because of a problem involving a tech product incorporated into your own product offering. At minimum you should be aware of the contract terms you’re agreeing to, and track relevant deadlines and dates. This checklist highlights substantive terms you should review for all contracts. Please note this is not an exhaustive list, and depending on your company and the particular contract, there may be additional terms that are important to review and negotiate, or you may decide some of the issues noted here are not critical for your company.
In addition to this checklist, there are plenty of resources to assist you with reviewing and negotiating contracts. You can use services like Termscout and Inkly to help with contract review and negotiation. For a more DIY approach, you can refer to websites like Law Insider or Tech Contracts for sample contract clauses. It’s advisable to consult an attorney for contracts that are very high dollar value, critical to your business operations, and/or involve complex integration with your company’s products, services, or systems.
10 key contract terms to review:
Term and renewal. Confirm the length of the initial contract term, and whether the term automatically renews or whether the parties need to sign a written agreement to renew the agreement. Many companies on the buy-side limit contracts to a maximum of 2-year terms and will not agree to auto-renew, to avoid getting locked into contracts.
Termination. Understand the circumstances when you’ll be able to terminate the contract before the term is up. Common termination clauses allow termination for material breach of the agreement. Additionally, one or both parties may have rights to terminate for convenience or not for cause. Depending on whether you’re selling or buying products or services, you may not want the other party to be able to terminate the contract other than in cases of breach.
Cost. Confirm the potential total dollar value of the contract and what factors could cause an increase in pricing (such as additional users/seats). If the contract is for services and you’re paying hourly rates, consider negotiating a “not-to-exceed” amount to avoid budget overages without your advance approval.
Intellectual Property. If the contract involves you sharing copyrighted, trademarked, or patented material with the other party, make sure you understand the scope and duration of the right you’re granting - for example, are you granting a limited license during the term of the agreement for purposes of providing services under the agreement?
Services/Deliverables. Make sure the contract’s description of services and deliverables matches business people’s expectations. For deliverables, consider who will own the work product - will the customer own it, or will the vendor retain ownership and grant the customer a license?
Data.
If the contract requires you to share data with another company, make sure the contract clarifies the scope and duration of their ability to access and use your data, and requirements for returning or deleting the data on your request and/or at the end of the contract.
Make sure it’s clear whether the other party is a Service Provider (also known as a Processor under GDPR) or not. If the company you’re contracting with has broad rights to use your data for their business purposes, be aware of potential risks under privacy and data protection laws in the U.S., E.U. and other jurisdictions. You might need to have a separate agreement solely to govern the data rights, known as a Data Processing Agreement (or DPA). Consult an attorney to figure out if this is necessary.
If the contract involves personal data (such as for a healthcare or financial services contract), confirm that the other party has an appropriate security program in place.
Indemnification. An indemnification clause outlines the scenarios where a party will cover third party claims against the other party (including settlement costs and defense of the lawsuit). The indemnification could be broad and cover third party claims related to the contract, or could be narrow and cover only intellectual property claims (which is more common for technology providers). When you review indemnification provisions, consider:
Whether the indemnification is mutual or one-way.
What claims are covered and whether they relate to the types of risks you would be concerned about (IP, data security/data breach, etc.).
Limitation of Liability (LoL): Limitation of liability is considered one of the most important sections of a technology contract. The LoL provision caps one or both parties’ liability - for example, at the contract value - and many companies will not take on uncapped liability. The LoL may include carveouts for claims that are not subject to the cap, or that are subject to a different, higher “supercap”. The provision also commonly excludes indirect damages, such as consequential and punitive damages. When you review LoL provisions, consider:
The economics of the deal and the particular risks.
Whether the LoL is mutual or one-way.
What is carved out from the LoL and whether the carveouts have a supercap. It’s common to have carveouts for IP, indemnification, confidentiality, and privacy/data claims.
Your insurance coverage limits and whether they are in line with your liability exposure.
Confidentiality. The contract should clearly identify what constitutes “confidential information.” Typically company data and personal data are included in the definition of confidential information, and the agreement terms themselves may be confidential. Confirm how long the confidentiality obligations remain in place - do they expire after a certain number of years? Similar to company data, the confidentiality clause should address returning or deleting confidential information on your request and/or at the end of the contract.
Publicity. Be aware of the publicity rights built into the contract - does the other party have the right to identify you publicly on client lists and marketing materials, and is your prior approval required for publicity? These rights are important to locate and decide on.
Some additional operational considerations for your startup with regards to contracts and contract management:
Set up a simple contract management system. There are plenty of contract management services and products for startups. It’s also possible to set up a DIY contract management system.
Set up an approval process. The contract approval workflow will evolve over time. For early stage startups, it is important to make sure everyone in the company is aware of who needs to approve a contract. Criteria may be based on dollar value, type of contract, length of contract, or other factors that make sense for the business.
File signed contracts. Make sure you retain a copy of the final signed contract, and any addenda or amendments to that contract. It’s advisable to have a central location for all signed contracts, such as a file on your shared drive. This file will become part of the data room you share with prospective investors. Check out our “Short Startup Fundraising Preparedness Guide - specifically the section regarding your data room.
Track contract deadlines. Make sure you have a user-friendly system to track key dates for your contracts, in particular any deadlines to renew or terminate the agreement. This can be done in a simple Google sheet, Airtable, or similar format. We also recommend calendaring and setting reminders for key dates such as deadlines to renew or terminate contracts.
Consider a contract playbook. If the company has a standard approach to common contract terms, you may consider building a playbook so team members can efficiently review and comment on contracts. This is something your attorney could create for you, or partners like Inkly can get you set up with a standard playbook. The 10 items in the “Check Key Contract Terms” above are a great starting point for developing your playbook.