My last post concerning structuring to meet the needs of your financing sources, has led me to think about how to handle contracts. Businesspeople are often willing to go “skinny”. That is to say they are willing to live with contracts that are not comprehensive or rigorous. They often rely on relationships and accepted business practices (or simply trust). In many ways, this is what makes the world go around. The mere creation of a thorough carefully drawn contract that covers every (almost every) contingency and the negotiation that implies may itself be an impediment to doing business. 

A lot of the time the sales guy writes up the contract, the CFO signs off on it and the world rumbles on. If the relationship works and no third party ever has to look at it – you are fine. But, what happens when a third party gets involved. I am thinking particularly about what happens when you go to sell the business and the buyer is a Fortune 50 company (or even a Fortune 2000 company) that does not have a strong “personal” relationship with your counterparty? Or, what happens if you go to a financing source such as a name brand VC?

Family businesses (and my family used to have one, so I know) can operate at a level of informality that venture financed businesses just can’t ever get to. When IBM (or any other large buyer of companies) acquires your business, they want (need) to know that they will be inheriting the vendor and customer relationships. Assuring IBM that you and your customer have an understanding and are very simpatico just wont cut it. 

VCs get this, and they expect their portfolio companies to be set up for an exit. That means that informal arrangements (perhaps except for immaterial matters) are just not acceptable because they diminish the marketability of the portfolio company. If you are planning to get VC funding, you should assume that the VC will review your contracts (at the very least all the important ones) and a company with a squishy key contract may not be financeable (at least without an amendment to the contract).

Consider having to go from the easy squishy contract to the level of definition and tightness that IBM (or any other similar buyer) or a VC proposing a financing will want, under the pressure of a pending exit or pending financing. Your bargaining power just went out the window and your good will with the customer or vendor just went down the tubes. The moral to the story is that an ounce (or a several ounces actually) of prevention is better than an pound of cure.