Contracts Part II: Laying the Groundwork

5 small business contract insights to ensure your deal is comprehensive.

A client who calls up his attorney a few days in advance of a closing on a transaction to instruct counsel to come up with some type of agreement is likely to become frustrated at the length of time it takes the critical agreement to be drafted and negotiated.

This is because the principal expects the attorney to develop the architecture for the deal, which really should be the responsibility of the principals, themselves.

Here are five insights to ensure your deal is comprehensive:

1.  Save Time: Think through the Deal

So, before you instruct counsel to come up with a draft of a contract, think through the deal in detail and jot down its important elements:

Ask questions to yourself, such as who is on the other side of the transaction, what is the object of the transaction, where are the parties’ actions going to take place; do affiliated businesses need to be involved; does the transaction concern foreign partners.

How are profits and costs going to be affected and/or allocated; is there expected to be a ramping up period; are the terms governing employees going to have to be altered. How is management going to be affected; how is payment going to be made.

If there is a termination, what will happen to pending contracts, etc.

The object is to visualize how the business relationship is going to unfold in practice. Imagine all the issues that are going to have to be addressed and flag problem issues for the consideration of counsel.

2.  Develop a Term Sheet

With very simple transactions, developing a Term Sheet may not be efficient, but for complex transactions, involving hundreds of thousands and even millions of dollars. 

A Term Sheet is an excellent way for the parties to determine the broad structure of their prospective business relationship before a lot of effort and resources go into drafting the correspondent agreement.

 As a rule, a Term Sheet (sometimes it is presented as a Letter of Intent) should run a few pages—one to three pages, if possible.

The objective is to be able quickly to ascertain the general scope of the transaction and to identify how important issues have been resolved.

An example of what not to do is to enter into the contract drafting process only to end up realizing that your transaction partner has a very different conception of how to calculate a profit participation than you do.

Not only can this type of problem waste a lot of attorney time, but it can also lead to more adversarial negotiations and diminishing confidence in the deal.

The upshot is that all material aspects of a transaction or relationship should be negotiated out by the principals in advance of moving forward with the drafting of the actual agreement.

If parties have not resolved important issues relating to pricing, profit sharing, cost allocation, sales targets, etc., they should not expect legal counsel to do it for them.

Next- Insights 3-5 insights of the deal