There is a reason contracts are notoriously tricky to understand. Many small business owners choose to skim a contract rather than reading the fine print, but this can ultimately lead to signing off on clauses you were unaware of.
If you are an entrepreneur or startup founder, it’s likely you’ve encountered a fair share of contracts thus far. Seeing as contracts are legally binding, it’s essential to understand what you’re agreeing to and some of the major contract red flags.
1. Noncompete Clause
A noncompete clause is used to protect the intellectual property of a company. When signing a noncompete clause, employees, partners, or even clients will agree not to share confidential company information. Although noncompete clauses are not inherently bad, it’s essential to watch out for tricky or deceptive wording in the fine print such as the time frame or geographic location.
2. Liability and Indemnity
Liability clauses outline how much money is owed if something goes wrong, while indemnity clauses establish who is financially responsible for the damage. As a small business owner, you need to be especially wary of liability and indemnity clauses as just a few words in it could ultimately lead to the demise of your business.
3. Automatic Renewal Clause
An automatic renewal clause is a tricky tactic that automatically extends the contract unless agreed otherwise. In B2B industries, automatic renewal clauses are often buried deep in the fine print of a contract making them especially difficult to identify. Be on the lookout for automatic renewal clauses as they could end up costing your business heavily if missed.
4. Termination Clause
Termination clauses are common in contracts—but you should be looking carefully at the wording to ensure the reasonings for termination are specific and defined. When looking at a termination clause, be sure there is not a provision that allows your client to unreasonably terminate the contract without compensation.
5. Ownership of Work
Ownership of work clauses are used to specify who the owner of any work produced under the terms of the contract is. Be wary of contracts that require you to give up ownership rights to the work you completed, as this can be a major red flag regarding the integrity of the company.
6. Contracted Parties
When signing a contract, it’s essential to ensure the basics like date, time, and parties involved are correct. While it may seem like an obvious step, the importance of this is paramount—a mistake in this can be extremely costly for your business. Make sure to double-check the details, particularly the parties involved, to ensure the financials of the contract are going where they are supposed to.
Understanding contract red flags is an essential skill for small business owners, who don’t often have a lawyer on-call to look over their business documents. For a complete guide to business contracts and some telltale warning signs to look out for, check out the infographic below.