The Hidden Costs of Handshake Agreements: Protecting Your Business with Written Contracts
In the early stages of a business, trust is a foundational element. Entrepreneurs often rely on trusted relationships with co-founders, early employees, vendors, and investors to build operations, establish supply chains, and shape their business structure. While informal agreements may seem natural in these initial phases, depending solely on handshake deals can create significant risks over time. Without formal contracts, businesses may encounter disputes, misaligned expectations, or legal challenges that could impede growth and stability. Establishing clear, well-documented agreements helps safeguard all parties involved and lays the groundwork for long-term success. From day one, contracts serve as the cornerstone of your business’s legal foundation, while handshake-only verbal agreements could ultimately undermine your success.
Why Handshake Agreements Seem Attractive in the Beginning
For small businesses during the startup phase, speed and flexibility are top priorities. The goal is establishing agreements quickly and efficiently, minimizing friction while ensuring key partners remain committed. However, what seems like a more efficient approach in the moment can create vulnerabilities down the road.
Handshake agreements often make business partnerships feel more personal, fostering a sense of trust and collaboration. While legal paperwork may initially seem like an unnecessary hurdle, and the cost of hiring an attorney may feel like an avoidable expense on a tight budget, overlooking formal contracts can lead to significant risks. Without clear, legally binding agreements, businesses may face disputes, misunderstandings, or unexpected setbacks that could jeopardize long-term success.
The Risk: What Happens When There’s No Written Contract?
Many new founders underestimate the risks of handshake agreements. Without written contracts, the business foundations you’ve built can collapse in ways that often blindside entrepreneurs—whether during critical early stages or as the business begins to scale.
People recall agreements differently over time. Without a written contract, there’s a much higher risk that you and your partners will no longer agree on the terms of the agreement. This can lead to serious conflicts and disrupt your business structure.
Difficulty of Legal Enforceability
While verbal agreements can be legally binding in many situations, they often present significant evidentiary challenges when disputes arise, making them difficult to enforce effectively. Without a written contract, parties may have different recollections of terms, leading to disputes that can escalate into costly legal proceedings where proving the exact terms agreed upon becomes problematic. If your business relies on handshake agreements, you may expose yourself to unnecessary risks, believing that informal commitments will hold up in critical situations.
Investor and Buyer Scrutiny
Well-documented legal agreements are typically important when seeking investors or planning to sell your business. Most sophisticated investors and buyers generally prefer to see formalized contractual relationships with key stakeholders. Investors and buyers need confidence that the business they are investing in has a strong contractual foundation. Without formal agreements with key stakeholders, suppliers, and partners, your business may seem disorganized or unreliable, potentially discouraging investment and growth opportunities.
Employee Compensation Issues
When an essential team member is promised a percentage of profits or a specific compensation package without formal documentation, you risk either disputes over the promised stake or losing that key person at a critical time.
Supplier and Vendor Disputes
A vendor may claim that they were guaranteed better payment terms, or a supplier may suddenly deny the special deal you worked out at the beginning of your partnership. In either case, the deal can fall through with no signed contract, or you can lose access/pricing that your business strategy was built upon.
Protecting Your Business with Written Agreements
Written formal agreements are your best protection for future growth potential when building your business. It is worth the investment of time and resources to draw up contracts for every partnership and agreement that forms your business’s foundation or operating network. However, the approach to formalizing agreements should be strategic and proportionate to your business stage, available resources, and the importance of each relationship.
For important business relationships, consider taking the time to clearly define the critical terms such as roles, compensation, equity, responsibilities, and expectations in your written agreements. This practice often helps prevent misunderstandings and provides clarity for all parties involved. It may initially seem counterintuitive, but clear terms are the cornerstone of healthy and productive business partnerships and team assembling.
Consider consulting with a legal advisor early in your business journey when establishing important relationships. A business lawyer can help ensure that your agreements align with your business goals and are structured to be legally enforceable in most circumstances. This ensures that the terms are enforceable and that both parties are responsible for upholding their part in the agreement.
The Cost of Avoidance is Higher Than the Cost of Preparation
Handshake agreements can be tempting when you are first building your business. But what feels like the unnecessary legal expense of drawing up contracts in the early stages can save your business from costly disputes when you start to grow.
Remember: written contracts aren’t just about protecting against bad actors. They can also ensure clarity, accountability, and long-term success for everyone involved.
If you plan to scale successfully and exit gracefully, you need a strong foundation of written legal agreements from the very beginning.
This article is provided by Solyco Capital for general informational and educational purposes only. It is not intended as and should not be relied upon as legal, tax, accounting, or investment advice. The information presented may not reflect the most current legal or regulatory developments. No information contained in this article should be construed as a recommendation to engage in or refrain from any particular business strategy or action. Readers should consult with qualified professionals for advice specific to their situation. Solyco Capital does not guarantee the accuracy or completeness of any information in this article, and is not responsible for any errors or omissions, or for any actions taken based on this information.
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