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A formal contract is a must for any start-up

Mar 25 2013, 16:51   |   By SME Mentor

Gargi Banerjee

Starting a new venture is exciting and once an entrepreneur makes some headway, he is so overjoyed at the prospect of doing business for the first time that he often makes one cardinal error - failure to get into a binding contract with his clients. Sure, initial clients usually come from past networking relationships or as referrals. But that's' no reason to skirt formalities.

The absence of a contract can delay payments and lead to even bigger problems, where a bigger client may not pay up at all! There have been instances where small business owners have had to shut shop because they could neither recover payments from clients nor afford an expensive legal battle. So read this carefully.

"Failure of clients to pay up on time or not at all is one of the main reasons for the failure of start-ups in India," reveals Siddharth Mahajan, founder and managing partner of Auxillium Partners, a Delhi-based law and consultancy firm that specialises in start-ups. "The threat of legal action often does the trick with errant clients but this needs the backing of a formal contract."

Here are the whys and wherefores of a formal contract.

1. First, Determine The Terms

A business contract must clearly spell out details such as the nature of services provided; the benchmark against which work will be evaluated; and, most importantly, the mode, manner and time of payment. There is no place for vague terms such as 'reasonable time frame' or 'subject to satisfaction'. Other critical details are terms of dispute resolution and termination of the contract. Start-ups tend to ignore the latter two terms as they want to turn a blind eye to the possibility of unpleasant developments or are naïve enough to believe that things will not go awry.

2. Seek Legal Counsel

While all this sounds simple enough, one needs a thorough grounding in the Indian judicial system to actually draw up a contract. And, no, the Internet is no substitute for hiring legal counsel. Unfortunately, the Indian legal system does not have separate legislation for start-ups and treats all businesses alike. This is why a bigger company with more experience can stamp out a smaller, first-time entrepreneur if there are loopholes in the contract or, worse still, if there is no formal contract at all!

3. Safeguard Intellectual Property

An entrepreneur is unlikely to know about the Indian Contract Act, which must be adhered to while drawing up any contract. Laws pertaining to Intellectual Property (IP) must always be kept in mind, especially if your start-up is in the creative field or any other IP-sensitive business.

4. Hire Affordable Legal Counsel

A formal contract is the very basis of a business agreement. "These documents should be considered the core of the relationship between a start-up and its client, an advisor, employee or investor," explains Mahajan. Therefore, it is mandatory to seek legal advice, which should be budgeted for at the planning stage. Obviously, a start-up may not be able to afford big law firms but the good news is there are many boutique law firms that hire the services of sharp, commercial and corporate lawyers who specialise in advising start-ups. Legal fees for such firms can vary between Rs 10,000-1,00,000, depending on the size of the start-up and the experience of the lawyers.

So, regardless of how small your business is, make sure you enter into a formal contract before you shake on a deal. At the very least, your professional approach from day one will win you brownie points with angel investors and venture capitalists at a later stage!

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  •  SME Messenger |   Mar 25 2013,04:49