Most entrepreneurs have signed a contract at some point in their lives prior to starting a company, but the types of contracts (and related agreements and documentation) used by companies for day-to-day “transactional” commerce are new to most entrepreneurs.
We’ll walk you through what you’re likely to run into in the first year of running an online company. We’re not lawyers, so rely on your lawyers for legal advice, but this will hopefully help you have a more productive discussion with your lawyers about what documents you need drafted.
Letters of Intent
A “letter of intent” (LOI) (sometimes called a “memorandum of understanding” (MOU)) is a tool for sales. Some of them are contracts in their own right; some of them are not. The point of them is to force the two parties to agree to rough terms on paper, generating a signal of commitment to do a deal, without actually agreeing to a deal.
LOIs are extremely useful for businesses. Some scenarios:
An entrepreneur may want to sell a part of their business to another company. This sale will quite possibly require “due diligence”—an in-depth inspection of the books, records, and processes of the asset—being conducted by the buyer. Due diligence can be extraordinarily disruptive to day-to-day operations of the business, and is something which businesses do not want to offer to mere tire kickers. Additionally, due diligence will expose the potential buyer to sensitive information from the selling business.
Accordingly, sellers will try to sign LOIs with prospective buyers, which soft-commit the buyer to purchase “contingent on the successful completion of due diligence.” These will often include (or be paired with) a non-disclosure agreement, which will prohibit the buyer from exploiting or publicizing information which they receive from the seller in due diligence.
It’s clear what the acquirer gets from this arrangement: access to detailed information about the asset, which they wouldn’t get absent the LOI. It’s less obvious what the seller gets. Typically, they pre-load some of the negotiating into the discussion about the LOI—asking the acquirer to pre-commit to consequential offer terms like price or timing. This comes with an understanding: violating the LOI leaves neither party with recourse to a court of law, but the assumption is that attempting to violate it will kill the negotiation about the actual sale.
LOIs are also a cheap but real signal of actual interest in getting a deal done. It is very, very easy for many people at any company to say yes to a meeting and say any number of positive sounding things at that meeting. “That sounds like a great idea!” may be the least expensive sentence to utter in the English language. Forcing the production of a formal document, however, activates impulses in real businesses like legal departments and corporate officers. The legal department of a real company does not sign documents just to be polite. Forcing one’s counterparty to go to their legal department and generate work for them demonstrates that one’s counterparty is at least willing to pay some nominal social cost to continue a conversation.
For related reasons, LOIs are extraordinarily useful for customer development. Many internet companies begin without a clear vision of what they’re building. If you talk to prospective customers about their problems, they’ll often be able to describe them in much detail. If you say “I want to solve your problem, with software”, then they’ll often be very supportive of that, out of a combination of reflecting your enthusiasm and wanting to be polite. But that doesn’t mean they’ll actually buy.
It is difficult to sell software which won’t exist for six months, and many entrepreneurs aren’t comfortable doing it. It is far less difficult to simply ask your prospective customer for a soft commitment like an LOI. “Great, I’m glad that you like the idea. Will you agree to an LOI where, after we deliver this in approximately six months, you commit to doing a 3 month pilot at $1,000 per month followed by a $5,000 per month rollout if the pilot is successful?”
The conversation around the LOI will often discover things that merely talking about the problem didn’t. For example, the prospective customer might say “Oh, wait, I don’t have budget”, which feels like a painful thing to hear but is actually a very useful step in the conversation. You can ask them who at their company has purchasing authority/budget, how they could get budget, what would cause them to describe this software as something budgetable (a feature that put it in another team’s budget? a services component?), etc. You could also simply move to finding a customer who can actually buy your software.
Many companies have died because they built something no one wanted to buy. Your company should not be one of them. Ask for LOIs or other indications of clear, sustained interest before building your products; only produce things which you’ve successfully been able to find prospective buyers for.
Master Services Agreement
Broadly speaking, companies sell two things: products or services. Products often don’t have a very detailed contractual story to them: you pay your money, you get your product, the end. (Your lawyer will tell you that there are excellent circumstances to have substantial contracts around the sale of a product. Take their advice over this generalization.)
Services, on the other hand, almost always are governed by contracts, and the contracts get very extensive. Larger companies often have preferred contracts (sometimes called “[our] paper”) which anticipates their core concerns about buying services and makes sure that the provisions they want are in the contracts. Smaller companies might, on the other hand, prefer to work off their vendors’ paper.
Since customizing a contract for every possible services engagement (many of which are different from each other) would be unwieldy, the services industry often breaks their contracts into two parts: a master services agreement (MSA) and one or more statements of work (SOW).
The exact line between what terms go in one’s MSA and which terms go in one’s SOW depends on how one’s lawyer, or one’s client’s lawyers, decide to draw them. In general, details about the overall scope of the relationship go in the MSA, details about the particular project go in the SOW.
Statements of Work
Statements of Work (SOW) are used by many services companies, when paired with MSAs, to decrease the complexity and cost of negotiating contracts by using a core contract negotiated once (the MSA) and then attaching individual addenda (the SOW) for discrete engagements, projects, etc. The SOW are contracts, and subject to contract review and negotiation, but they’re generally less contentious than the MSA.
SOWs generally include agreement about:
- Scope—what work is to be done
- Deliverables—specific identification of what should be given to the client
- Price—either a single number or a rate (per unit, per employee-week, etc)
- Timeline—when the major milestones are due for the work
- Acceptance criteria—what constitutes “good enough to get paid” work and what constitutes a fault which needs revision
Acceptance criteria are one of the most important commercial terms and among the easiest to overlook. For example, if acceptance relies on a named officer of your client sending you written acknowledgment that they’ve inspected the deliverables, your language defaults to non-acceptance: unless that officer does work (inspection) on your behalf, your work doesn’t get accepted. You can ask your lawyer to give you language which defaults to acceptance. In this model, you give your client a limited time to lodge a written objection to the deliverables after the expiration of which they will be “deemed accepted”. This puts the onus on your client to check your work in a timely fashion.
This is much more reliable at getting your work accepted without problems, and changes the tenor of the client interaction. Instead of badgering someone who you need a good relationship with to say “Please drop what you’re doing and check this thing for me; I want to get paid”, you’re simply sending polite reminders “Hey, just a quick note: remember you have until Friday to lodge any objections, if you need to. This is just for your benefit; if you don’t have any objections, no action required.”
So you’ve done the work and want to get paid. How do you ask a customer nicely for money? With an invoice.
An invoice is simply a formal written demand for payment. Since the presence of them is used as a control factor at many companies, particularly larger ones, you will likely want to issue them. The exact formatting is far less standardized in the United States than it is in many countries.
Typically, an invoice will include:
- An itemized list of the goods or services purchased, with minimal detail about them
- A unit price and quantity for each line item
- A subtotal
- Any sales tax assessed
- The total amount invoiced
- The total amount actually due, if not the same as the amount invoiced (i.e. if the customer has already paid a portion of the invoice)
- Your address
- Your customer’s name and address
- Payment terms
- Payment method instructions
- A PO number, if you were provided one
Most of this is fairly self-explanatory. The exceptions:
PO number: If you’re doing business with larger companies or government agencies, they may have issued you a formal purchase order (PO), which is tracked with a PO number. They will not pay any invoice unless it has their PO number on it. This is an accounting control—the person working in Accounts Payable has no personal knowledge of whether your demand for payment is authorized or not, so they’ll want to see it pre-authorized by someone inside the organization (via a purchase order that they can look up) prior to sending you payment.
Payment terms: For the convenience of your customer, you will generally put the payment terms (which were negotiated and in the MSA or SOW) on the invoice. The most common payment term is “NET 30”, which means that the invoice is due in 30 days from the date it was issued. Companies not paying invoices on time is extremely common in the U.S.; this is one reason why nudging customers to use credit cards or similar at the time of order is so popular.
Payment method: Companies which pay invoices will overwhelmingly want to pay you with checks. You probably don’t want to accept payment in checks, and so will include payment instructions, such as “Please pay us via ACH using the following information:” This instruction will routinely be disregarded and you’ll receive a check in the mail anyway, at any address you have written on your invoice. For this reason, you should be careful to put a working address on your invoice.
U.S. invoices do not customarily include corporate ID numbers or anything regarding VAT taxes. Many internet companies which do business worldwide will ask their customers “Is there anything we should put on your invoice?”; European companies will generally ask for their VAT number to be on it, for compliance with tax obligations.
It is not common to issue invoices for payments which have already been made (a receipt is generally more appropriate for that purpose), but if you do, you should put the amount paid, the date paid, and a notation to let the processing entity know that they don’t have to pay anything further.
A quirk of many of your customers: people expect invoices to look like an official document, so putting your logo on them, delivering them as a PDF, and putting a bit of work into the design will make it more likely that they’re accepted than simply delivering the same content as plain text. Some of your customers will ask you for a “real” invoice even if they have all the information from you as plain text already.
Customers, particularly business customers, rely on companies to help them organize their finances. You should offer customers a written receipt for every transaction with you, particularly for transactions which are settled instantly (via, e.g., a credit card) or otherwise not invoiced.
Receipts are formal documents, but even lower-ceremony than invoices are in the United States.
Typically, you’ll write on them:
- Your business’ name and address
- An itemized list of what was purchased, in minimal detail
- A subtotal
- Any sales tax assessed
- The total amount paid
- The date and time of purchase
You can optionally add:
- How the payment was made (“credit card with last digits 1234” is common)
- The customer’s name
- A reference number for you to find the transaction later
- Instructions for the customer if they have a question about the purchase
If you’re selling to consumers as opposed to businesses, but some of your customers are actually purchasing for business use, they will often “expense” the purchases to their employer. Their employer will require a receipt for this process. This can, depending on your business, be a core use case for receipts. Many of those customers will want the receipt “to look official”, so much like invoices, having something which is “not just plain text” can be useful for decreasing the number of inquiries you get about your receipts.
Customers frequently lose receipts. If you have a persistent relationship with a customer, it is a good idea to keep a copy of their receipts in their account on your website/online store/etc. This will help them out, and save your team from having to answer many questions of the general character “I need a receipt for my purchase to file my taxes. I think it was back in July. Can you help?”Back to guides