How I read a contract

I’ve noticed, while talking to many young people, that reading and understanding a contract may be a challenge sometimes, especially when the contract is a very important one (investment, company sale contract or simply “the contract of a lifetime”).

It’s for these big contracts that I’ll try to tell you in the following paragraphs how I go about it:

Necessary steps:

1. The business: You must know exactly what the deal you’re signing is, where you want to go with this contract (at the end, even if potentially there are more stages), what each of the parties gives and gets. In general, this is established in a one page Term-Sheet, without any details, just the essentials of the agreement. It’s not necessarily important to have a signed Term-Sheet, but it’s important for you to have the deal very clearly and completely defined in your mind;
2. The mechanics of the deal: What the steps through which you get to the end are. Different terms, milestones, payments, structure etc.
3. The architecture of the contract: Each contract has a way of phrasing the deal. This turn of the phrase must be understood very well, so that when you read an article, you know exactly when it applies.
4. The terms of the contract: Here is where negotiations begin. Important terms – minority rights, options, control… – all of them must be understood and placed in the context of the points mentioned above;
5. Little details: cross references, definitions, checking the math, grammar.

You must understand and treat your most important contract as a project: strategy, architecture, details. You must pay attention to all of its elements and slowly it must “take shape” in your head.

As you gain more experience, you can let your lawyers handle more of the above. However, you, the entrepreneur, must always be in full control and understand all that is happening. Speaking from the point of view of lawyers (please challenge me if I’m wrong), the more the client understands and the more he gets involved, the more the lawyers can help him.

Suggestions in terms of logistics:

• It may be useful to read it in pairs: one should pay attention to the whole and the other should pay attention to the details;
• Any contract must be read line for line and word for word, understanding every little thing, as if each situation described there is going to happen. Pay attention to all cross-links – there may be more than one and they may have potentially major implications;
• The contract is read keeping in mind all the evils of the world. This is the only time you should think your partner will screw you (excuse my language), the earth will sink and so on. Suggestions from the “others” such as: “Come on, let’s sign it like this because this thing can never happen since we’re partners and we share the same interest” are unacceptable in the contract phase. After you sign it – yes;
• According to the importance of a contract, I read it twice to 5 times over. Each time I read it differently, in another light, with another focus. And this goes for one round of contract circulation. After that, I send it with comments to the “others”, they send it back, and I enter another cycle;
• I make notations on the side to know and return only to the important things after review: * = must re-read or take minor action, ! = must notify lawyers or major action, ? = must ask because I didn’t understand, NO = unacceptable (it comes together with “!” 🙂 ), grammar, bad link and others;
• It’s good to know where yourinterests are aligned with your partners and where there’s a potential conflict, in order to know where to put more effort in protection;
• I comment with someone close to me, even if he’s not a professional, in order to check the principles;
• Don’t get bored when you read – after the first 120 pages you risk saying “this is clear, this is clear…”. Don’t get careless when it comes to your most important contract;
• Lawyers may help a lot. Butthe deal is yours, so you must understand everything in the contract;
• Read it all at once, otherwise you’ll forget the connections 🙂
• Don’t be shy to ask your lawyers everything you don’t understand. You must understand ALL the contract – I think I’ve said this 4 times, but it’s very important;
• When you get to a reference (link, definition) – check it. Someone malicious might sneak a lizard there;
• I’ve seen many contracts in which the math was wrong. For example, an amount is set, then mistakes are made when calculating and nothing comes out right anymore. Basically, it’s up to the lawyers to do this, but then again…Check the math;
• Read every paragraph keeping in mind that it can refer to what is obvious, but also to something without an apparent connection but that could radically change another paragraph;
• Explain to your lawyers the best way you can what your business interest is. This is how they’ll know how to better help you;
• Try to keep the same lawyers. They’ll start knowing the areas you’re sensitive to and the areas you’re willing to take risks in;
• When you have comments, talk them through with your lawyers, then (you or your lawyers) draft the comments you’ll send to the other as clearly and non-confrontationally as possible.

Altogether, a contract of 70-80 pages takes me two to three two-hour sessions for a revision.

And one last suggestion: a meeting is worth 100 emails with comments.

Disclaimer: I haven’t tried to relate anything about the negotiation part here, but only about reading/understanding a contract. Otherwise, I would’ve had to write a book 🙂

(English version by Teodora Popescu)