The Contract ROI Trap

Several weeks back, 37signals asked “Employment Contracts: What are they good for?” on Signal vs. Noise. Basically, they questioned the value of their employment contracts since they have never had an employment dispute:

“Why have we become so dependent on lawyers to control every relationship inside our companies? Why is “just in case” the default answer when asking questions about contracts? It sounds more like insurance than legal counsel. And the premiums are sky high.”

I get it. No one likes to pay for anything without receiving a quantifiable ROI.

For example, I’ve worn my seat belt, bought cars with airbags, and paid for car insurance since I was 16. But I’ve never had an accident, moving violation, or even a parking ticket. Where’s my ROI?

But should I ditch my seat belt and/or car insurance because I’ve never been in an accident?

I am lucky that I haven’t gotten into a car accident. Who knows when and if my luck will run out? Also, my lack of tickets and accidents could also mean I’m just a really cautious, alert driver. I suspect 37Signals is just a really good employer, and maybe they have been a bit lucky to avoid employment-related issues thus far.

The best way to prevent employment issues is to install good employment practices (i.e. be a good employer). But if the shit hits the fan, you’ll be much better off with a great employment contract. Much like you’d rather have insurance, an airbag, and your seat belt on if you get into a car accident.

I don’t counsel new startups to vest their founders shares so that I can increase my “insurance premium” charge (and for what it’s worth, I don’t charge any more or less for drafting a stock purchase agreement with vesting or fully-vested shares). I counsel new startups to vest their shares since I’ve seen plenty of startups fail because their shares didn’t vest.

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And I’m guessing 37signal’s lawyers have seen many clients go through painful employment-related disputes.

(Disclaimer: The author of this post gets paid to draft contracts.)

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10 thoughts on “The Contract ROI Trap

  1. The gist of the problem is borne out by your example – looking at the aggregate ROI of greater investments in automobile safety clearly demonstrates the benefit. Individually, you may never realize a return on that investment but for those that do it can literally be a life saver.

    Now turn that question to tight employment contracts – especially on say a 3 year trailing analysis – what if any benefit does an employer derive from the non compete, the IP protections clauses, and the other CYA legalese? I would be very interested to see actual case studies that demonstrate benefit, not that I doubt that some benefits exist, but I do doubt the actual big picture benefit to an organization, to an industry, to our economy.

    Looking just at the past 3 years is crucial given the evolution of employment law in our jurisdiction (Oregon). Noncompetes basically were outlawed several years ago. IP protections appear to me to be unenforceable for small companies if only because of the cost of litigation. Maintaining agreements given every evolving law and interpretation of law has real costs.

  2. The gist of the problem is borne out by your example – looking at the aggregate ROI of greater investments in automobile safety clearly demonstrates the benefit. Individually, you may never realize a return on that investment but for those that do it can literally be a life saver.

    Now turn that question to tight employment contracts – especially on say a 3 year trailing analysis – what if any benefit does an employer derive from the non compete, the IP protections clauses, and the other CYA legalese? I would be very interested to see actual case studies that demonstrate benefit, not that I doubt that some benefits exist, but I do doubt the actual big picture benefit to an organization, to an industry, to our economy.

    Looking just at the past 3 years is crucial given the evolution of employment law in our jurisdiction (Oregon). Noncompetes basically were outlawed several years ago. IP protections appear to me to be unenforceable for small companies if only because of the cost of litigation. Maintaining agreements given every evolving law and interpretation of law has real costs.

  3. This is a really hot topic right now as lawyers make their rounds trying to drum up business as the economy, and hiring, picks up. We had a freshly minted lawyer going around to developer user groups providing legal advice on employment contracts here. I attended the first one and have to admit that as an advisor to dozens of startups and a even a few interactive agencies I was a bit concerned that this guy was green and potentially dispensing bad advise. He isn’t the only legal guy out there telling people how to do business. These days you really don’t have to rely on a laywer to come up with a contract – you can download one on from a variety of websites or just get one from a peer who had one drawn up. While I would not advise someone to do this, I’ve seen it happen quite a few times. I am sure there are people out there who would have others believe that they’ve never made a bad hire, had labor dispute, etc. like the guys from 37 signals claim. I say claim because I’ve heard stories and even if I hadn’t it wouldn’t matter – they’re no different from any other organization. Oh, I suppose they are a lot better at PR than many others in the same class of company they are in. By that I mean they pick the hot topics of the day and talk about them to draw attention to themselves and to their products. Hey, it works – they’re blogging for bucks in practice. But back on topic, disputes aren’t for sunny days – they’re for the days when dark clouds hang over your company. They are there to set expectations for when things don’t go the way one or both parties wants them to. They’re there for providing a pre-planned solution to a problem so that when two or more parties disagree or when things get heated there is an already agreed to way out. Think of contracts as the chill out button for people who reach that undesirable hothead stage. Perhaps another way to think of a contracts, for employment or whatever, is as a set of tracks for your startup roller coaster to ride on. When things get wild you know where things are going and don’t have to worry about running off the road or a head on collision that could have been avoided. Lawyers, by their nature are specialists in collision avoidance. Get a good lawyer who knows their way around this stuff and you sleep better. One last thing – I wouldn’t think of employment contracts as insurance as much as I would think of them as crash safety features for companies. A crash safety feature protects both the employee and the employer just like it protects the passengers and the manufacturer. Better to do all that you can vs. nothing at all.

    Disclaimer: I’m not a lawyer.

  4. This is a really hot topic right now as lawyers make their rounds trying to drum up business as the economy, and hiring, picks up. We had a freshly minted lawyer going around to developer user groups providing legal advice on employment contracts here. I attended the first one and have to admit that as an advisor to dozens of startups and a even a few interactive agencies I was a bit concerned that this guy was green and potentially dispensing bad advise. He isn’t the only legal guy out there telling people how to do business. These days you really don’t have to rely on a laywer to come up with a contract – you can download one on from a variety of websites or just get one from a peer who had one drawn up. While I would not advise someone to do this, I’ve seen it happen quite a few times. I am sure there are people out there who would have others believe that they’ve never made a bad hire, had labor dispute, etc. like the guys from 37 signals claim. I say claim because I’ve heard stories and even if I hadn’t it wouldn’t matter – they’re no different from any other organization. Oh, I suppose they are a lot better at PR than many others in the same class of company they are in. By that I mean they pick the hot topics of the day and talk about them to draw attention to themselves and to their products. Hey, it works – they’re blogging for bucks in practice. But back on topic, disputes aren’t for sunny days – they’re for the days when dark clouds hang over your company. They are there to set expectations for when things don’t go the way one or both parties wants them to. They’re there for providing a pre-planned solution to a problem so that when two or more parties disagree or when things get heated there is an already agreed to way out. Think of contracts as the chill out button for people who reach that undesirable hothead stage. Perhaps another way to think of a contracts, for employment or whatever, is as a set of tracks for your startup roller coaster to ride on. When things get wild you know where things are going and don’t have to worry about running off the road or a head on collision that could have been avoided. Lawyers, by their nature are specialists in collision avoidance. Get a good lawyer who knows their way around this stuff and you sleep better. One last thing – I wouldn’t think of employment contracts as insurance as much as I would think of them as crash safety features for companies. A crash safety feature protects both the employee and the employer just like it protects the passengers and the manufacturer. Better to do all that you can vs. nothing at all.

    Disclaimer: I’m not a lawyer.

  5. Thanks for a great post, I never thought of it like that before.

  6. Thanks for a great post, I never thought of it like that before.

  7. @ David – The benefit of having a tight employment contract includes the ip assignments, etc. My clients would have a hard time getting funding or going through a sale if the IP ownership wasn’t easily established.

    @ Bob – Couple of points:

    (1) I think the line between legal/business advice can be blurred most of the time. Also, flatly rejecting any business advice offered by a lawyer probably isn’t a good business practice.

    (2) No document treasure trove is going to replace a lawyer. It’s kind of like saying that developers aren’t necessary if all code was open sourced.

  8. @ David – The benefit of having a tight employment contract includes the ip assignments, etc. My clients would have a hard time getting funding or going through a sale if the IP ownership wasn’t easily established.

    @ Bob – Couple of points:

    (1) I think the line between legal/business advice can be blurred most of the time. Also, flatly rejecting any business advice offered by a lawyer probably isn’t a good business practice.

    (2) No document treasure trove is going to replace a lawyer. It’s kind of like saying that developers aren’t necessary if all code was open sourced.

  9. While 37signals is fortunate in no having had a problem with employment disputes, as an attorney, I can cite numerous examples where good drafting would have saved thousands.

    My dentist could probably name some examples of lack of attention to toothcare leading to pain down the road as well—even if I'm not the best brusher.

  10. While 37signals is fortunate in no having had a problem with employment disputes, as an attorney, I can cite numerous examples where good drafting would have saved thousands.

    My dentist could probably name some examples of lack of attention to toothcare leading to pain down the road as well—even if I'm not the best brusher.

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