All businesses carry out transactions, from hiring employees and scheduling contractors to forming partnerships and seeking financial backing.
But is it always necessary to formalize things with a written contract?
Let’s look at the purpose of a contract and explore why contracts are important for establishing business relationships and protecting everyone’s interests.
What is a contract?
A contract is a legal agreement that sets out the terms of a transaction, deal, or exchange between two or more parties — which may be individuals or companies.
You might sign a contract to buy real estate, accept a job, or enter a business partnership. A sales agreement also counts as a contract.
Contracts outline the rights and responsibilities of each party, as well as the costs, benefits, and details of how the contract may be terminated.
They’re basically a promise that you’re going to take a certain action, such as completing work by a stated date or paying the other party for services rendered.
Both written and verbal contracts may be legally-binding, but it’s best to have a written document for business agreements.
It’s essential that both parties understand the full agreement and its obligations, and show a clear intention to accept the terms.
This is demonstrated by a signature, which is part of what makes a contract valid.
If you’ve never drawn up a contract before, you might be unsure of what to include.
PandaDoc has a full library of contract templates that you can use for different situations to ensure you don’t leave anything out.
The purpose of a contract
The purpose of a contract is to establish and formalize a relationship by clearly defining the terms and obligations.
It ensures all parties understand what they’re agreeing to and that there’s no room for misinterpretation.
Signing a contract demonstrates your commitment to the agreement and shows you are trustworthy, which helps in building strong relationships.
After all, as set out by the Harvard Business Review, trust is the basis for almost everything we do.
The document can also be used as a reference if either party wants to check the terms at any point.
Contracts offer legal protection in the event of a dispute and can be used in a court of law if necessary.
However, a clearly-written agreement can actually help you avoid drawn-out arbitration or even going to court at all, saving your business time and money.
To be enforceable, contracts must contain these seven elements:
- Identification. The definition of all the parties to which the contract applies.
- Offer. The promise that one or both parties will (or will not, in the case of non-disclosure agreements) perform a specific action.
- Consideration. Where something of value is promised in exchange for the actions.
- Acceptance. An expression that both parties have agreed to the terms.
- Awareness. Proof (such as signatures) that both parties clearly understand and agree.
- Capacity. Each signatory has demonstrated the “legal capacity” to understand what they’re signing.
- Legality. All contracts are subject to the laws of the jurisdiction under which they operate.
Why are contracts important in business?
The importance of contracts in business cannot be overstated.
Whether you’re a startup or a multinational enterprise, robust contracts contribute to the smooth running of your company.
Here are 10 reasons why they’re essential.
1. They act as a representation of obligations in writing
Business contracts create a reliable written record of the obligations involved in the transaction, whether it’s carrying out a project, meeting a deadline, or paying a specific sum of money on a certain date.
By putting this agreement into writing, you’re formalizing the arrangements and showing you take them seriously.
Each party demonstrates with their signature that they intend to honor the agreement, and both sides can then be held accountable for the terms of the contract.
A written record also means the contract can be referred to at any time.
2. They highlight the necessary details and expectations of the agreement
Contracts also set out how you’ll maintain the working relationship and how long it’s expected to last.
They highlight the duties of each party, how they should be performed, and how they will be tracked and measured.
As well as stating how the arrangements should work, the contract outlines what happens if things don’t go to plan.
For example, what if your roofing contractor can’t meet the deadline for completing the work because of poor weather?
What fees or penalties would be incurred for late payment of rent on a property?
Although you don’t want the contract to be too unwieldy, it’s good to cover all bases.
This saves you from having to re-draft the contract or create an addendum if something crops up that’s not covered.
3. They ideally help generate more revenue
Another reason why contracts are important is they can help your business increase its revenue.
For one thing, a robust contract guarantees you’ll receive payment on a specific date, so your cash flow will be predictable and you can make business decisions accordingly.
With careful negotiation, you’ll be able to set terms that are beneficial to you, such as agreeing to a higher fee for the services you offer.
You can also grow your business through improved vendor relationships.
Plus, if you use document workflow software like PandaDoc, you’ll be able to speed up the contract process.
Getting contracts finalized quickly means you can sign more deals and bring in greater revenue, as well as reduce missed opportunities and time-consuming admin.
4. They ensure confidentiality
When it comes to what to include in a contract, all businesses need to consider confidentiality.
It’s common in business transactions to add a confidentiality clause or non-disclosure agreement (NDA).
In fact, a significant study published in 2015 revealed that over one-third of the US workforce was bound by an NDA.
Times may have changed a little since then, but the figure is still going to be significant.
You might include these because you don’t want certain details to be made public, such as your financial status or the secret recipe for your restaurant’s house special.
Some businesses ask the other party to sign an exclusive contract, which means they can’t enter into relationships with other providers or competing companies.
A contract that includes confidentiality clauses should state what happens if someone is in breach of contract and the legal enforceability of the agreement.
5. They alleviate risks and avert disputes
Written contracts are the best way to protect your business against risks, such as loss of money or legal disputes.
Because the details have been negotiated between the parties, with opportunities to raise any concerns, the signed contract should prove that both sides are happy with the agreement.
Of course, this doesn’t stop unscrupulous people from ignoring or breaking the terms of a contract — such as a builder disappearing with your deposit or tenants refusing to pay for damage to your rental property.
However, it ensures you have recourse if the worst happens, including legal action.
A clear agreement will show who’s in the right.
6. They boost the effectiveness of operations
Contracts improve efficiency because they clearly define what both parties are supposed to be doing and when.
If you hire a freelancer to create a video for your website by a specific deadline, you shouldn’t need to waste time chasing them up.
Or, if you’re expecting a payment, you can go ahead and order more stock as you can be confident the money will arrive.
Efficiency also gets a boost when you manage contracts online. Instead of sending emails back and forth, you can edit and sign documents in a few clicks.
And with cloud storage, your contracts are easy to locate for future reference.
7. They aid overall compliance and adherence to legislation
As well as being a legal document itself, a contract can help you maintain compliance with relevant laws and regulations.
For example, you might need to consult industry-specific or state-specific legislation on things like the use of personal data.
The process of creating a contract focuses your attention on such matters, and the document can become a useful reference point if you want to check compliance policies in the future.
If you’re unsure, it’s a good idea to take legal advice on the compliance elements of a contract.
8. They maintain strong cooperation and interaction
The collaborative nature of the contract process has benefits for internal and external relationships.
During the creation stage, teams and departments in your business can share input, alongside close negotiations between the parties entering the agreement.
Contract management software enables collaboration on a contract without having to email multiple versions, which minimizes delays and helps prevent errors or disputes.
By starting your working relationship on the right foot, you can maintain effective cooperation.
9. They give assurance and satisfaction to all parties
All types of contracts help ensure security and peace of mind on both sides and build an atmosphere of mutual trust.
Once a contract is signed, this legally binding agreement gives everyone confidence that its terms will be adhered to — and that they’ll be protected if things go wrong.
As we mentioned, any issues should be ironed out at the negotiation stage, so both parties are satisfied with the arrangements.
In addition, the right software for contract management and tracking can provide a comprehensive audit trail of every edit or comment made, lending transparency to the process.
10. They solidify your organization’s image and philosophies
Contracts, particularly if you use them frequently, can be seen as an extension of your company brand. We’re not just talking about putting your logo on the front cover.
A high-quality contract presents you as a professional and trustworthy business, willing to commit to agreed terms.
A contract proves you care about keeping a record of your relationships and that you’re staking your reputation on their successful outcome.
People who do business with you can then expect the same level of care during the contract lifecycle.
Leverage PandaDoc and reap the benefits of accurate contracts
By now, you should be aware of why contracts are important for small businesses and large companies alike.
By clearly defining rights and obligations, they protect you against future disputes, demonstrate your professionalism, and help you generate extra revenue.
If you use software like PandaDoc, you can also improve efficiency by reducing the amount of time contracts take to create and sign.
This means you can easily draw up legally binding contracts from templates containing all the essential elements and get them signed electronically.