Start-ups and the Problem of Enforcing Contracts

Start-ups, especially bootstrappers, don’t usually have extra cash lying around. This isn’t necessarily a bad thing, and there are many benefits to cultivating lean production models. Doing more with less becomes a craft in itself. However, it does present one gigantic problem, a problem that careless or ill-intentioned clients can easily exploit. That problem lies in the incentive structure of service contracts.

In the creative content world, contracts are ubiquitous. Whether it’s securing permission to film or photograph at a particular location, contracting the terms of your talent or ironing out expectations of a client, the rule is: get it in writing. Particularly clients. People change their mind, “forget” and get side-tracked into different projects all the time. They change phone numbers and addresses. The people you’ve spent hours of meeting time developing personal connections with will change jobs, or get laid off. As Dennis Cahill notes, many start-ups innovate to make existing services available to a new market segment, which means that your customers may simply be unaccustomed to paying for your service. If you ever make the mistake of completing work without signing a payment contract, unless that client has been a personal childhood friend or blood-relative of yours, you should not expect to be paid, ever. Anecdotal experiences to the contrary are the result of luck. If one of your business partners say “let’s trust this guy, he seems honest and I have a good relationship with him” be twice as suspicious than if the person was a complete stranger. Why? Because duplicity is really the only way you can actually get something for nothing. For some people, every human interaction represents such an opportunity.

Businesses who get part or all of their revenue from services know to be careful. Those that aren’t are eventually going to get burned. But what about if you’re careful, if you get everything in writing and signed and witnessed? Is that enough? Not a chance. Why? Because you’re a start-up, that’s why. If someone decides that they don’t want to pay you, they know that your recourse is most likely a law-suit. They know that means time in court and money for legal fees that no one in your company has. Depending on how their business is doing, maybe there wouldn’t be anything worth suing over. They know that they can wear you down, play the waiting game and eventually they’ll win. They calculate (correctly) that the recourse against enforcing a contract is usually not a plausible option for most creatives. By the way, these power-driven relationships are also true of freelancers, see Robert Bowen’s excellent article on recourse that independent designers and developers have against non-payment.

This difficulty with enforcing agreements can be a substantial source of anxiety for service-driven start-ups. The ball can always seem to be in the client’s court, as you wonder if payment will ever be forthcoming. The trick to managing this problem is controlling the conditions under which the ball crosses from one party’s court to another.

Many service businesses simply demand payment up front, but for start-ups who may be trying to get customers to try something new, this is often not a realistic option. At the outset, you need to be open with your clients about the need to be compensated in a timely manner. You need to set deadlines for compensation that parallel the deadlines for final product delivery, and make sure that these are explicit, in writing and mutually agreed upon. Scheduled payment plans or deposits are a good way to do this, since they create routines and expectations – after a manager has breached the psychological barrier or paying for a new service, perhaps something that they’ve never paid for before, it will be easier for them to do it again. As Ted Hollified has noted, you never have as much leverage as during the contract negotiation phase, so if figure out what your make-or-break clauses are early, and don’t get mealy-mouthed about saying what they are. It’s important that companies take chances on start-ups, and there’s a lot of opportunity out there. But it’s equally important for start-ups to be aware of the dangers of getting burned, and to not give up every ounce of leverage in a service arrangement at the outset, relying on the good nature and intrinsic benevolence of clients as a guarantor of badly-needed revenue.