Legal 101 For Startups: Contracts and What Goes into Creating Them

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This is the 2nd post in our series titled Legal 101 For Startups. This post will primarily focus on that one animal that most startup founders are terrified of; contracts. We’ll take you through everything and more that goes into creating a solid contract.

The reason contracts are such scary animals is because when someone is handed over a 50 page contract full of fancy words and jargon, they’re bound to get intimidated. However, always remember, 30 out of those 50 pages are pure jargon that is meant to intimidate you. So, worry not!

A few things you need to be clear about when drafting or looking at a contract are as follows:

1. The scope of work: Usually people tend to take startups for granted by trying to squeeze them for whatever they’re worth. The easiest way to avoid being a victim of this is to have a clear cut scope of work defined in a contract. Also, make sure you have a realistic timeline that goes hand in hand with your scope of work. The last thing you want to do is over-promise and not be able to achieve whatever it is you promised.

2. Payment: You must first define your payment system. Is it going to be milestone payments or progressive payments. Ok, so for those who don’t know, a milestone form involves the contract having fixed performance items, which release some part of the payment every time a performance item is achieved. This also gets related to your scope of work because you get paid as per what you’ve delivered. If somebody wants you to do some additional work for them, you can charge them for that separately. Progressive payments on the other hand are when the contract states, that over a period of time, payments will be made as and when work progresses without any fixed performance goals being listed.

3. Liability: The next thing to consider is what is your liability in case something goes wrong. For example, In the event that a customer who’s using your service wants to sue you, how will you go about protecting yourself? Well, there are two ways of doing this, a Time Cap and a Money Cap.

  •  Time Cap: This means that you cannot be hit by a claim post 3, 6, 9, or 12 months after your service has been used by a customer or after your product has been sold.
  • Money Cap: This means that you can have a 100 claims thrown at you but the amount of money that you’re liable to pay is limited to the amount that you were originally paid for your service or product, plus an x multiplier. This allows you to set the amount that you’ll be paying if and when you get sued.

4. Dispute resolution clause: This is very important especially when you’re dealing with foreign clients as foreign clients aren’t comfortable with the Indian judicial system for obvious reasons. So they try and arm-twist you into agreeing to arbitration in a foreign country. You need to push back on this (we know that you guys probably aren’t in the position to throw away a customer, but you have to push back). This is because if on the off chance that you do have to go through arbitration abroad, it can cost anywhere between $25,000- 50,000. Also, it’s always better to be on your own home turf as you know the rules and can play the game. It’s also more important for you to have the home turf advantage being a startup.

5. Terms and Conditions: You also have to ensure you have your terms and conditions drafted out and put up on your website. Do not ever make the mistake of copy pasting your competitors terms and conditions with the thought of ‘who reads them anyway?’. Always make sure your terms and conditions and disclaimers are all in place!

6. Non Disclosure/ Anti Poaching Contracts: People have also started making ‘potential’ employees sign a non-disclosure agreement as they don’t want the potential employee taking undue advantage of knowing/having sensitive company information. We’re also seeing a lot of people working out of coworking spaces do the same by making people sign anti-poaching agreements as usually when you’re in a coworking space, you tend to share your ideas.

7. Employee Agreement: This agreement shouldn’t just have the basics like the date of joining and HR policy details, but must also factor in things like whatever Intellectual Property the employee creates while being employed under you is owned by you and not by the employee. This is also very fair as while being employed under you, the employee is using your money and your services and facilities in order to create IP for you. Also, you are paying him for doing the same so all the work he does is technically owned by you. Also, make sure there is a clause that says that he cannot disclose any trade secrets that he learnt while being employed under you. Another few things you must include in your employee agreement are:

  • Non-Compete: Say if you have an employee who while working under you for six months understands everything about your business and decides to start his own version of your model. A non compete stops this from happening. It can’t be done for life but can be done for either 12 or 24 months and that’s generally more than enough time.
  • Non-Solicit: This ensures that if one of your employees is leaving, he cannot take five of your other employees along with him and go.

8. Cofounders Agreement: Always ensure you have a cofounders agreement in place. Even if you and your cofounders are best buddies you need to have a cofounders agreement if you want to be taken seriously. Also, no investor will entertain you if you don’t have one. Remember, a business is a business, do not mix it up with friendship.

This concludes part – II of this blog series. We hope this post helped shed some light on everything that goes into creating and understanding a contract. Stay tuned for part – III which will focus on two of the most important things for any startup, funding and valuation.

Everything in this blog post were learnings we had during a Legal 101 workshop that took place at our Noida hub. This workshop was conducted by Pratik Mohapatra who graduated from the National Law Institute in Bhopal and has more than 6 years of hands-on experience working with national as well as international startups. During his tenure with Platinum Partners which is one of India’s largest law firms, he closely worked with foreign investors who wanted to invest in Indian companies. After spending the significant amount of time in the corporate world and having built a name for himself in the field, he is now dedicatedly helping early stage companies structure their business and investments.

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