What to include and what to avoid in a vendor contract?

Image credit: Pexels

Key Takeaways

• A vendor contract (or vendor agreement) establishes the terms and conditions of a transaction involving a vendor (seller) and a startup (client). While the contract assists the vendor in determining revenue, it's all about keeping track of spending for the startup.
• Vendor contract management entails developing a dependable and standardized process from start to finish to assist in the management of the “four Rs”: risk, revenue, renewals and relationships.
• When drafting a vendor contract, founders should avoid an inadequate termination segment, an ill-defined exit strategy and inadequate protection for the contract’s parties. They should also avoid rushing through the process and employing ambiguous vocabulary that could come back to bite them later.
• Most formal vendor contracts contain similar legal terms, which are frequently in the same order. These are scope, timing, price and payment, termination and repercussions.
• When creating a vendor contract, the founder should define the terms of the business (which are normally outlined in the first section of each vendor contract), discuss legal concepts (the representations and warranties portion is typically the first item in this section) and lay down how to deal with the ramifications of things going wrong.
• There are some key pointers to remember when writing a vendor contract. Founders should know about the two approaches to vendor management and which one is better. They should have a well-defined planning procedure, get the contract documented, and then return to it frequently either through constant monitoring and evaluation or when one-off questions or problems arise. 

What is a Vendor Contract?

A vendor contract (or vendor agreement) establishes the terms and conditions of a transaction involving a vendor (seller) While the contract assists the seller or vendor in determining revenue, it's all about keeping track of the budget for the startup. If a company doesn't have a dedicated procurement team, which is often the case of a high-growth startup in its initial stages, then the legal department would typically handle these vendor contracts. 

Vendor contract management entails developing a dependable and standardized process from start to finish to assist in the management of the “four Rs."

Risk

What kinds of risks does the startup face as a result of its vendor agreements?

Revenue

What impact could these contracts have on revenue recognition?

Renewals

When do these contracts expire and how does a founder decide whether or not to renew them?

Relationships

What can we do to make the vendor-founder relationship healthier, and what can we do to improve things overall that are mutually beneficial for founders and vendors?

How does a vendor contract work?

The goal of a vendor contract is to ensure that all involved parties recognize the standards of performance that are expected of them. This includes quality of outputs, payroll, and so on through a transaction of products or services -- as well as the repercussions if such standards are not satisfied. By establishing contracts at the outset of every vendor relationship, startups are also better positioned to limit their risks. 

Here are some customizable sample vendor contracts for your perusal.

What to avoid in a vendor contract?

Let's discuss the worst blunders in a vendor contract that only become evident when a crisis occurs.

Inadequate Termination Segment and Exit Strategy

The first blunder is the lack of a well-thought-out termination segment and a proper exit strategy. Many founders have sometimes been trapped in contracts that they realized they didn't want to be in, only to discover that the contracts auto-renew or have conditions that favor the vendor over the startup. If you want to end the partnership but the exit strategy isn't well-defined, you'll have to waste time and headspace trying to figure out what to do next.

Inadequate Protection of Contract Parties

The next most frequent stumbling block is drafting an agreement that does not adequately protect all stakeholders or is unclear about how the (two) sides will work together to fulfill their contractual duties in a satisfactory manner.

Mishandling Confidential Information

Another area you should always review thoroughly is what happens to sensitive data when the partnership expires. In particular, you should confirm if the vendor’s responsibility to protect their clients' information does not cease when the contract does. 

Rushing through the process

The thought of hurrying through an agreement, or even embracing a generic one-size-fits-all deal, is the fourth typical error that founders make. Terrible stories abound involving founders who, with the greatest of intentions, just wanted to get a vendor contract signed but didn't analyze it thoroughly enough. Rushing through the drafting and negotiation process when dealing with vendors is never advisable  — think of it as short-term profit, long-term agony.

Ambiguous Vocabulary

Finally, an unpleasant yet all-too-common occurrence of a mistake that founders make is when the contract is ambiguous on crucial elements — in other words, it just does not define each party's obligations, expectations and responsibilities as clearly as it could.

Details to Include in a Vendor Contract

Contracts are drafted in a variety of forms (or formats) by vendors and startups. Despite this, most formal vendor contracts contain similar legal terms, which are frequently in the same order:

Scope

A vendor contract will typically outline the products/services covered by the agreement, as well as how they will be provided. Many potential blunders can be averted by explicitly outlining what each side anticipates in relation to the other.

Timing

Contracts with vendors should also specify when the vendor will be compensated, when the products/services will be delivered, and when the business arrangement will begin and end.

Price and Payment

The amount paid in exchange for the vendor's performance should be explicitly stated in all vendor contracts. Contracts must also specify how the vendor will be compensated, whether in the form of cash, in-kind contributions, debt relief or any other type of financial agreement.

Termination

A vendor contract establishes a business arrangement but it should also specify how and when that engagement will end, as well as any actions that either side can take if the work specified in the contract is not completed on time.

Repercussions

Vendor contracts will also spell out the repercussions if either party fails to meet their contractual responsibilities. This defines how both participants can resolve any conflicts that emerge while also guaranteeing that they are aware of the consequences if they do not follow the contract's provisions.

Creating a Vendor Contract

Creating a vendor contract really requires the assistance of an attorney to verify that it adheres to all related legal requirements and effectively protects all parties concerned. 

While the specifics of each contract may differ, most contracts follow the same basic structure:

Step 1: Define the terms of the business

Business terms are normally outlined in the first section of each vendor contract, and include:

• The client’s (or startup’s) legal name
• The vendor's legal name
• Each party's unique responsibilities, including the relevant specifics about the product, goods, services, or/and license
• Pricing
• Compensation terms

Step 2: Discuss legal concepts

The representations and warranties portion is typically the first item in this section. This section allows the contracting parties to express guarantees about the quality of the products/services being provided, their eligibility to sign the agreement and their compliance with legislation. This encompasses any confidentiality or indemnification clauses.

Step 3: Deal with the ramifications

The final section of the vendor agreement explains what happens if something goes wrong. Details that will be discussed in the contract include:

• When either party can terminate the contract
• If they will/can use lawsuits or arbitrators 
• What legislation will rule the disagreement

Types of Vendor Contracts

Vendor contracts cover a wide range of products/services, ranging from daily operations to one-time needs, activities and events. 

The following are some examples of regular vendor contracts:

Fixed Price Contract

The startup and vendor agree on a fixed (or predetermined) fee for a "well-defined product" independent of potential cost or quality overruns, setbacks, market volatility or other circumstances. Fixed-price contracts are usually reserved for low-risk circumstances involving well-known vendors.

Time and Materials Contract

A precise hourly rate and period of service are agreed upon by the vendor and the startup. These types of contracts are commonly used with third-party merchants, consultancies, freelancers or other outside contractors.

Cash Reimbursable Contract

The vendor and founder acknowledge that the vendor will be compensated for any work involved with the contract's fulfillment in addition to a standard price. When there is a higher level of risk and ambiguity associated with a product/service, this type of contract is commonly employed.

Letter Subcontract

The vendor and founder agree that during the "subcontract" period, a certain amount of the work will be accomplished, usually less than 40% of the whole program or project. When all of the contract specifics cannot be finalized before the project begins, this type of contract is commonly utilized (usually for large projects with lots of variables).

Indefinite Delivery Contract

The founder and vendor commit to a dynamic agreement with an unknown volume of products or, alternatively, an unknown period of service. A spectrum is used to define the initial and final expectations, rather than identifying extremely specific amounts of output. When numerous projects are being worked on at the same time, a “master agreement” is utilized to outline the entire scope of projects.

Distribution Agreement Contract

This is a type of vendor contract that specifies how, when and where a commodity will be distributed. Distribution contracts provide a distributor the authority to sell the vendor's products and, in most cases, profit from them. These contracts usually specify whether the distribution arrangement is exclusive or non-exclusive.

Tips for Writing a Vendor Contract

Know the two approaches to vendor management and which one is better

There are two approaches to bringing on a vendor to meet your needs. The first is reactionary, which involves only identifying and onboarding one when a need emerges. The second is tactical –- identifying a need before it becomes urgent and putting in place a mechanism to meet it as soon as possible. Although there could be times when you need to find a vendor on the spur of the moment (e.g., if an important piece of machinery malfunctions and your current supplier is unable to repair or replace it) there are numerous benefits to contracting outsourced products/services in a more strategic manner whenever feasible.

Have a well-defined planning procedure

To begin with, the more understanding you have of the industry and current offers (not to mention the more experience you have in evaluating similar previous vendor agreements), the better you will be able to evaluate the efficacy of a vendor proposal with regard to prices, deliverables and other factors important to your startup at that moment. This way, you can also eliminate issues like conflicting interests and develop ways for identifying vendors who may not be able to deliver on their promises.

You'll have plenty of time to assess compliance standards and any other needs that may influence your vendor selection. Any state/federal rules, industry-specific regulatory agencies and internal requirements should all be checked. With a planning process in place, you may define any other evaluation criteria ahead of time, giving you a clear framework for evaluating and comparing suppliers.

Get it documented

It's critical to document your arrangement in the form of a written contract and/or statement of work once you've vetted applicants and selected the best fit. A formal contract outlines your as well as your vendor's responsibilities and obligations under your working arrangement. A supplemental document known as a statement of work may be used in some situations to lay out the particular details of the job to be done by the vendor. While startups may utilize a single contract to control vendor relationships, it's not unusual for them to have an overarching vendor contract that spells out the entire relationship's conditions and then draft fresh statements of work to define the intricacies of each new project. In either case, these contracts will serve as a legally enforceable roadmap for your relationship with vendors if they are executed the right way.

Why is it critical to have everything in the form of a legal agreement? Because there must be a precise definition of what each party must do to fulfill their share of the agreement in order for all participants to perform as has been discussed and expected. A contract may include provisions about privacy, competitive employment and other issues in addition to the deliverables and compensation. You could want to try employing rewards in vendor contracts for delivering early or for other favorable results.

Come back to the contract frequently

Your contract is an enforceable instrument once it is signed, and each party is legally responsible for their responsibilities under the contract. As a result, your contract should be readily available to all relevant parties as an essential vendor management tool. While having a secure single repository for all the startup’s contracts is beneficial, it's also critical that employees in charge of managing vendor relationships have access to the relevant documents as required. This could be quite effective, whether as part of a continuous monitoring and evaluation plan — which is required to guarantee that deadlines, deliverables, and other milestones and requirements are being respected — or as one-off questions or problems emerge.

Learn more with us

• How to write a vendor contract?
• How to build a successful relationship with your vendors?
• How to handle vendor contracts?
• Tips to manage vendor contract negotiations

Access more guides in our Knowledge Base for Startups

We can help!

At AbstractOps, we help early-stage founders streamline and automate regulatory and legal ops, HR, and finance so you can focus on what matters most—your business.

If you're looking for help with understanding what to include and what to avoid in a vendor contract, get in touch with us.

Like our content?

Subscribe to our blog to stay updated on new posts. Our blog covers advice, inspiration, and practical guides for early-stage founders to navigate through their start-up journeys.  

Note: Our content is for general information purposes only. AbstractOps does not provide legal, accounting, or certified expert advice. Consult a lawyer, CPA, or other professional for such services.