Navigating Legal Contracts: An Entrepreneur's Guide to Key Business Agreements

Starting a new business involves entering into many important legal contracts and agreements. For entrepreneurs without legal backgrounds, the complex legal jargon can quickly get overwhelming. 

This comprehensive guide examines key agreements entrepreneurs regularly encounter, with simple explanations of each contract's purpose, critical clauses, pitfalls to avoid, and tips for negotiating favorable terms.

With a better understanding of these crucial business contracts, entrepreneurs can protect their interests and confidently manage the legal side of building a company.

Common Startup Contracts and Agreements

Here are key types of contracts often used by entrepreneurs during the startup process:

Partnership Agreements - Outlines rights and responsibilities between business co-founders. Details ownership stakes, decision-making authority, partner roles, vesting periods, etc.

Shareholder Agreements - Governs relations between shareholders if the business is set up as a corporation. Similar to partnership agreements.

Operating Agreements - Defines ownership percentages and operating rules for limited liability companies (LLCs). 

Investment Agreements - Spells out the terms of any investment rounds, including investor rights.

Convertible Note Agreements - Short-term debt that converts into equity shares in future funding rounds. A startup financing option.

Loan Agreements - Needed if obtaining bank financing or debt. Details repayment terms, interest, collateral, etc.

Intellectual Property Agreements - Covers licensing, royalties, confidentiality, and ownership of IP like patents, trademarks, and copyrights.

Let's explore each of these contracts in more detail.

( Read our informative article on What are Limited and Un-Limited Contracts )

Partnership Agreements

Partnership agreements are essential for defining co-founder rights and avoiding future strife. Key sections may cover:

Ownership Percentages - Specify each partner's proportionate ownership stake. Allows for vesting over time.

Profit/Loss Distribution - How financial surpluses and shortfalls will be shared. Often parallels ownership.

Decision Making - Procedures for making major business decisions. May require unanimous or majority partner approval. 

Partner Roles and Responsibilities - Delineates the specific functional contributions and duties of each partner.

Capital Contributions - Amount and form of assets invested by partners like cash, property, equipment, and IP. 

Withdrawal/Buyout Terms - Process if a partner leaves, including equity buyouts. 

Clear partnership agreements prevent confusion down the road as businesses grow and evolve.

Shareholder Agreements

Shareholder agreements govern relations between holders of company stock. Similar sections may include:

Stock Ownership - Classes of shares held by each shareholder, number of shares, percentages.

Share Transfer Restrictions - Limits on selling/transferring shares to outsiders to maintain control.

Dividend Policies - Formulas for distributing company profits as shareholder dividends.

Voting Arrangements - Procedures for shareholder meetings and election of the Board of Directors. 

Protective Provisions - Minority shareholder protections against changes by the majority.

Buy-Sell Provisions - Process for share redemptions if a shareholder departs or passes away.

For corporations, documenting share allocation, rights, and governance upfront avoids problems later.

Operating Agreements

LLC operating agreements lay out ground rules and include:

Ownership Structure - Percentages owned by each member. Can enable flexible share allocations.

Roles and Responsibilities - Delineates member and manager duties if manager-managed.

Capital Contributions - Defines member investments into the LLC at formation.

Profit/Loss Distribution - How net profits or losses will be allocated to members. 

Member Changes - Process for adding or removing members.

Decision Making - Management structure and voting procedures. 

Buyout Terms - How departing members can redeem their ownership interest.

This flexibility makes operating agreements useful for early-stage ventures.

Investment Agreements

Every funding round requires an investment agreement governing:  

Investment Amounts - How much capital investors will provide and milestones. 

Securities Issued - Number and type of ownership shares given to investors.

Investor Rights - Voting, first refusal on future rounds, information access, etc.

Restrictions - Limits on share transfers and added new investors. 

Redemption Rights - Terms for the startup buying back shares from investors.

Pay-to-Play Provisions - Requirement that existing investors participate in future rounds. 

Exit Rights - Investor's options for getting a return on investment like selling shares.

Well-structured investment agreements bring clarity to startup fundraising.

Convertible Note Agreements

Convertible note deals are intermediate startup funding options with:

Loan Amount - The principal amount provided to the startup through the note. 

Interest Rate + Maturity Date - Interest percentage and date the loan converts to equity or is repaid.

Conversion Discount - Percentage of discount on conversion share price to incentivize conversion.

Valuation Cap - Maximum valuation where note converts. Investor protection if valuation is high. 

Qualified Financing - Next equity round that triggers mandatory loan conversion when meeting set size.  

Change of Control Clause - Converts loan to shares if startup is acquired before conversion.

Properly structured convertible notes allow startups to delay valuation negotiations until future funding rounds.

Loan Agreements 

Taking out business loans requires formal loan agreements detailing:

Loan Amount and Purpose - Total amount and approved business uses.

Interest Rate and Fees - Rates can be fixed or variable. This may include origination fees.

Repayment Schedule - Monthly or other payment frequency and terms. Grace periods.

Collateral - Asset(s) secured as collateral the bank can seize if loan terms are breached. 

Loan Covenants - Legally binding promises to meet financial targets and provide financial information. 

Acceleration Clause - Allows the lender to demand full immediate loan repayment for covenant breaches.

Personal Guarantee - Requires entrepreneurs to personally guarantee the business's performance.

Loan contracts warrant meticulous evaluation to ensure affordability and prevent personal liability.

Intellectual Property Agreements

IP contracts ensure ownership rights to intangible assets like:

Trademark Licensing - Provides limited rights to use trademarks/branding for merchandise, etc.

Patent Licensing - This allows another party to utilize patented inventions and technology.

Copyright Licensing - Grants limited rights to reproduce, distribute, and display copyrighted works. 

Technology Transfer - Transfers ownership and commercialization rights for inventions, software, etc.

Confidentiality (NDA) - Requires third parties to keep sensitive information secret.

IP Assignment - Transfers IP ownership rights from individual creators to the business. 

Royalty Agreements - Provides ongoing royalty payments to IP rights holders from generated revenue. 

Protect innovative assets and IP through ironclad agreements.

Key Contract Negotiation Tips for Entrepreneurs

When reviewing contracts, keep these tips in mind to strengthen your position:

Take Time for Due Diligence - Read carefully and research unfamiliar terms before signing anything.

Hire Legal Counsel - Have a lawyer experienced with startups review substantial agreements when possible.  

Clarify Ambiguous Language - Flag vague clauses and push for specific, measurable terms.

Outline Major Dealbreakers - Know fundamental provisions you won't compromise on. 

Request Bidirectional Changes - Don't immediately accept one-sided proposals. Negotiate terms mutually beneficial to all parties.

Amend Inapplicable Boilerplate Clauses - Customize templated contracts to fit your distinct situation. 

Add Exit Strategies - Include realistic termination provisions in long-term contracts.

Thoroughly understanding contracts enables stronger negotiations. Don't rush the legal details!

Key Takeaways for Entrepreneurs

•  Form essential business agreements like partnership and shareholder agreements upfront.
•  Closely review investor rights, equity stakes, and exit scenarios in investment contracts.
•  Make use of convertible notes when needing to defer valuation.
•  Scrutinize loan terms like interest rates, collateral, covenants, and personal guarantees. 
•  Secure licensing agreements to leverage others' IP, and protect your innovations through assignments.
•  Negotiate contract changes that address your most pressing business needs and constraints. 

By mastering these common startup agreements, entrepreneurs can confidently manage partnerships, financing, IP, and other intricate legal aspects of growing a company. Just take it step by step!

Common Entrepreneur Contract Questions

What's the difference between an NDA and an IP assignment contract?

An NDA merely requires third parties to keep confidential information secret. An IP assignment transfers ownership rights of intellectual property to the company.

Should I form an LLC or a corporation?

LLCs require less paperwork and compliance than corporations. But corporations provide more options for growth like issuing stock. Evaluate tax considerations as well.

Are verbal agreements ever enforceable?

While technically valid, verbal contracts are difficult to substantiate. Always get binding agreements in writing.

What happens if I breach a contract? 

You can be sued for monetary damages by the other party. Breaching major agreements like loans allows the other party to take serious actions like seizing collateral assets.