Contract Counsel

Can you tell us about the initial forms and contracts that must be exchanged between companies that want to form an alliance? When do you use a letter of intent? A joint-venture agreement? How can you make sure they hold up?

Brett Truett


Soft-Noze USA

Utica, N.Y.

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Actually, with handshakes and oral agreements alone you can go a long way toward forging a watertight strategic alliance. But at critical points in the process, when the terms start to firm up, it's always best to rough out a contract and run it by your lawyer. "It's nice to have a piece of paper filed away in case of an emergency, such as a management shake-up," explains lawyer Fred Steingold of Ann Arbor, Mich. Of course, there are plenty of transactions for which contracts, to be valid, must be penned rather than spoken. Check your state's statute of frauds for those transactions.

Handshake agreements work fine as a starting point when "virtual company" builder Paul Farrow and his alliance partners get into serious negotiations. "We use a handshake as a precursor to a written agreement of mutual expectations," says Farrow, founder of Walden Paddlers, a kayak maker in Concord, Mass. (See "Virtual Realities," August 1993, [Article link].) "We've never used letters of intent or layers of contracts. We know what we want. Our agreements work because we test them."

Test them? "Yes, we call it a four-point transaction test," Farrow explains. "The first part is to make sure we're both working toward the same mission, which could be a single transaction or something that changes life as we know it." Second, both parties must have clear expectations about the scope and schedule of the deal. They must both get clear benefits from the association, too. And surely not least, says Farrow, the parties must trust each other.

Speaking of trust, Steingold suggests you draw up a confidentiality agreement that allows parties to share vital financial and strategic information without worrying about leaks if the venture doesn't pan out. If your would-be ally's tax reports and industry-specific documents are hard to decipher, you should include a clause that allows each company to share information about its prospective partners with its accountants or lawyers -- the people who can see the less obvious conflicts of interest that could later rip your alliance apart.

After that, depending on time constraints and the scope of the deal, you could sign a letter of intent that "sets the ground rules" of a still-hazy deal, says Steingold. The document can be as sketchy or as precise as you wish, but at the very least it should spell out what the parties are expected to accomplish within, say, 30 or 60 days. As the relationship matures and the stakes increase you may want to lock yourselves in for the long term with a more formal and comprehensive joint-venture agreement. "What's important here isn't what kind of contract," stresses Steingold. "It's the process of analyzing the deal and forcing each other to think about the details."

Luckily, there are workbooks filled with ready-made partnership and alliance agreements that also explain how and when to use them. Recommended are Stephen Elias and Marcia Stewart's Simple Contracts for Personal Use (Nolo Press, 800-992-6656, 1994, $16.95) and Daniel Sitarz's The Complete Book of Small Business Legal Forms (Nova Publishing, 800-462-6420, 1991, $17.95). Consider, too, top-selling software packages. "These templates are good starting points because you'll want to add your own clauses," Steingold says.

Walden Paddlers' Farrow agrees. The recurring elements of his agreements, which have been committed to floppy disk, include production quantities, flexible schedules, logistics, and any other expectations that can be quantified. Once each side has mapped out its own part of the bargain, says Farrow, "we sit down on the same side of the table and figure out where we want to go." Steingold likes that simple logic: "It's not the contract that makes it work," he says. "It's the meeting of the minds."

Barter? Beware!

What are some tips for shopping among bartering companies?

Kevin Nikkhoo


Vertex Systems

Los Angeles

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We're glad you asked. Commercial barter, which has long been used to supplement the cash transfers of hulking corporations on the New York Stock Exchange, is becoming popular among small companies. Practitioners, some of whom claim that up to 25% of their business is conducted via noncash trades, say it's an economical way to improve cash flow, move inventory, and open up new markets -- in short, to conduct business during lean and flush stages of business development. Barter exchanges, which number about 400 nationwide, are sprouting up everywhere. But this industry, like most others, has its share of shady characters.

To wit: Seasoned swapper Greg Murtha relates a story about a barter company he once worked with, whose significant accounting "error" would have cost his company $10,000 if he hadn't done his own detective work. "The barter company was printing funny money," he says. Today Murtha, director of sales and marketing for Angel Fire Resort, a ski and golf venue in Angel Fire, N. Mex., has an internal system of checks and balances that keeps his barter exchanges honest. His advice: beyond doing the usual business reference checks (Better Business Bureau, chamber of commerce, current and former users), ask the barter company itself for the name of its governing association, and call that group to get a reading on the exchange's reputation.

Before you begin to shop, figure out what goods or services are the most cost-effective for you to trade. Begin by dissecting your income statement and balance sheet to find out which assets are performing (and when), and how poorly performing assets can be redeployed or traded. Case in point: Murtha wouldn't dream of pledging meals or stays during peak ski season or golf tournaments because at those times rooms will likely be snatched up and paid for well in advance. In addition, Murtha suggests you and your bookkeeper give yourselves a crash course in transferring "soft" barter dollars, which are considered taxable income. "Keeping track of them gets really messy really quickly," he warns.

Once you have a list of the products or services you need, call around for estimates of what each costs in its market, to be sure a barter exchange's bid is fair. When looking for airtime for a radio ad, Murtha settled on the Austin-based Barter Exchange because its bid was competitive and its reputation for excellent service and selection preceded it. A few well-placed phone calls revealed that the market price for a minute-long spot on a Dallas station was about $250, Murtha says. "We were ready to negotiate if it bid $300, but we didn't have to."

Now you're ready to interview barter exchanges. (For some names of exchanges, see "How Swap Deals Pay Off," Financial Strategies, April, [Article link].) Be sure to determine whether the exchange has a national presence. Does it have specialty subsidiaries? What products and services can its other members offer? You'll want to ask about an exchange's range of consulting programs (some offer such services) as well as its cash-to-trade ratio guidelines and general contract flexibility. Consider, too, the barter business's onetime enrollment fee (which can be up to $600), annual dues, and commissions taken on transactions (8% to 10%, usually based on volume of goods).

Overall, you want an exchange that encourages you to negotiate fees up front and to set reasonable terms of expiration on your own offerings. "We're still honoring trades we negotiated years ago because bartered lift tickets were good for three to five years," says Murtha. "Now lift tickets are good for one ski season. Sleep-overs are good for a year. The game is, 'Use it or lose it."

Bringing Production Back Home
My company produces metallic business cards. After three years of rocky subcontracting, I am equipping my own full-scale printing facility. What warnings do you have regarding the transition from subcontractor to full manufacturer?

Baron C. Hanson

"Head Buckaroo"


Charlotte, N.C.

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In an age when more businesses are farming tasks out, you're thinking of housing manufacturing under one roof? That kind of counterthinking is the stuff of entrepreneurial legends, says many-time company builder Randy Kirk, president of AC International, a maker of bicycle accessories in Santa Fe Springs, Calif. "The pendulum's swung so far in favor of virtual over vertical that there are sure to be plenty of opportunities."

Only you can tell if your leadership style can stretch enough to accommodate the operation of a plant and the people inside. You're the one who knows if you have the financial resources to buy the requisite land and equipment, and the wherewithal to hire and train talented people. But, says Kirk, facility and personnel outlays are just the beginning.

Kirk, who recently wrote a column that extols the virtues of vertical integration ("It's About Control," August, [Article link]), offers some advice for handling the more frustrating questions that crop up during the transition:

How do you figure out what production elements you should bring inside first? The key here is to answer the question on both a gut level and a more scientific level. "In many cases, it boils down to necessity," Kirk explains. For example, you might want to quickly bring inside the tasks of suppliers that are chronically late on delivery or produce less-than-perfect components. At the same time you should run a reality check by doing a thorough cost-versus-savings analysis, complete with ratios such as returns on investment. "You can't go on emotion alone," says Kirk.

Is there any way around the typical scheduling snafus that plague new manufacturers as they initiate production? "As a rule, you'll need an extra 30 to 60 days beyond the target delivery date of your worst-case scenario," says Kirk. Most inexperienced manufacturers have no clue that it takes at least five people to install a huge chunk of machinery. "And once it's there, you can bet it won't work right the first time," he says.

How steep is the learning curve for subcontractors that make the move to full manufacturing? "It's shaped like a cliff," says Kirk, who admits that his own lack of manufacturing expertise nudged him into outsourcing back in 1981, before the strategy was fashionable. But Kirk says you'll go far in flattening out that curve if you or one of your associates is particularly good at hiring and managing engineers. n -- Reported by Karen E. Carney