Dealmaking: What About the Fine Print?

By — on / Business Negotiations

Adapted from “What About the Fine Print?,” first published in the May 2007 issue of the Negotiation newsletter.

Choosing the right words for your contract is a negotiation in itself. Five guidelines will help you achieve greater precision.

When negotiators sign on the dotted line, they sometimes worry about the wrong concerns.

“Did I overpay?” wonders the buyer as he inks the sales agreement.

Across the table, the seller is thinking, “I bet if I’d pushed a little harder, I would have gotten more.”

Yet it’s the words that surround the numbers that often are more important—and harder to get right. Take a simple real-estate deal. Isn’t it better to sell your condo for $400,000than for $375,000? Not if the higher-priced deal is contingent on the purchaser’s sale of her current place. Likewise,the lowest price isn’t necessarily the best for the buyer if it doesn’t include exit provisions for a bad title or termites.

Sophisticated negotiators understand that a successful deal often hinges on hammering out the right contract language.In fact, choosing the wording is a negotiation in itself, one with its own unique pitfalls.

Five guidelines can help you master this difficult task:

  • (1) define the deal before you set the price,
  • (2) know the words’ worth,
  • (3)balance precision and flexibility,
  • (4) avoid doom and gloom, and
  • (5) negotiate the relationship.

1. Define the deal before you set the price

Lots of us know Carolyn Keene as the author of the Nancy Drew mysteries. Actually, that’s a pen name. Midwestern journalist Mildred Wirt Benson was paid a flat fee of between $125 and $250 per book for ghostwriting 23 of the 30 original books in the series.

When Benson began writing, in the midst of the Depression, that wasn’t bad money.Unfortunately,Benson Released her rights to the character in her contract with Stratemeyer Syndicate. After the series took off, the publisher cut Benson’s fee to just $75 per book. When Benson quit, the publisher simply hired others to write as Carolyn
Keene. The Nancy Drew books have earned millions over the years but not for those who wrote them.

Now consider the college dropouts whom a corporation hired for short money to provide operating-system software for a new line of home computers.The company used its clout to drive a hard bargain on price, but the young programmers shrewdly added a deal clause that would enable them to sell the software to other customers.As you may have guessed, the company was IBM, and the dropouts were Bill Gates and his friends.

Since then, their start-up,Microsoft, has done pretty well.It was contract language, not price, that determined which side got the better deal in these examples. In one instance, the more powerful party dictated the terms. In the other, the nimbler party saw potential value that the larger entity overlooked.

Bargaining can get tough, of course,when both sides are envisioning pots of gold. Less powerful negotiators thus face a delicate task: arguing for their desired language without overemphasizing its importance.

2. Know the words’ worth

Haggling over dollars doesn’t leave much room for creativity, but it does have the advantage of clarity.

If you’re the buyer and the seller is dropping his price, you’re moving in the right direction. If the numbers are going the other way, you’re not.

How do you measure success when you’re trading words,not numbers? The key is to remember that words are means to your goals, not ends. Take the noncompete clauses that employers often seek to prevent top talent from fleeing to the competition. Because most recruits don’t want to be handcuffed, hard bargaining can result. But securing non compete language isn’t worthwhile if it’s unlikely to be enforced—and courts often disfavor such provisions.

College administrators learn this time and time again.For instance, in the summer of 2006, football coach Bobby Petrino signed a 10-year, $25 million contract extension with the University of Louisville—but took a better job six months later. Within days of his departure, Louisville found a successor by raiding the University of Tulsa; just before jumping ship, Tulsa’s coach, Steve Kragthorpe, had extended his contract through 2011.

Instead of battling over language that’s difficult or costly to enforce, look for other ways to achieve the same goal. To retain employees, for example, organizations can try one of two options: incentive clauses that vest benefits only after a certain number of years of service or “clawback” clauses that require repayment of signing bonuses in the event of early departure. A prospective employee facing such a proposal must weigh the present value of a future easy exit. The more attractive the job, the less important constraints may become.

Whenever you negotiate, be sure to calculate the tradeoff between tangible economic benefits and possible limits on your options—and ensure that compromises on one front are compensated by gains on another.

3. Balance precision and flexibility

Over the years, J/Boats, a successful sailboat designer and marketer, has done many millions of dollars of business with its manufacturer, TPI Composites. The companies’ agreement is summed up in a single-page contract.Now consider the reams of fine print you’re handed when you replace your cell phone. Why is one deal done virtually on a handshake while the other is weighed down with legalese?

The simplicity of the J/Boats-TPI contract was a practical necessity. When their partnership began in the late1970s, neither side knew whether the business would grow or how to specify the cost and price of boats not yet conceived.Adapting as the market and technology evolved was essential, as was building mutual trust and confidence. Any attempt to spell out details would have been futile.At the other end of the spectrum, though consumers rarely study their cell phone contracts, these documents cover a specified set of issues, such as contract length,scope of service, and repair costs. The provider dictates the language governing these issues, but consumers have some latitude to choose the sort of package they want.

Many transactions fall between these two extremes,requiring some specification of rights and responsibilities while leaving certain terms open-ended.Trying to cover all the bases takes time and can obscure understanding.Straightforward statements of principle may provide more guidance than stacks of boilerplate.

Often, early clarity disappears in successive rounds of contract renewals. In such cases, the time may come to wipe the slate clean. Several years ago, a utility company and its major unions were burdened by contracts that had grown to hundreds of pages. The company felt hamstrung by archaic job descriptions; workers were unsure of their job security. Starting from scratch, the parties were able to craft a new 12-page agreement that satisfied both sides interests and that was easily understandable.

4. Avoid doom and gloom

Lawyers frequently are blamed for the unintelligible fine print that pervades contracts, often with due cause. After all, they’re the ones who insist on warranties, indemnification
clauses, and liability limitations.Given that lawyers are responsible for protecting their clients from potential harm, however, some of this criticism is unfair. If Mildred Benson had had a good lawyer, she might have gotten her fair share of the Nancy Drew franchise.

(Conversely, if IBM’s corporate attorneys had paid closer attention to the company’s old with young Bill Gates,the computer business might have evolved quite differently.)

But when attorneys focus on who owes what to whom in every imaginable worst-case scenario, they cast a pall on even the most promising deals. The remedy for negotiators? Keep sight of the big picture. A successful Chicago real-estate developer tells a story about a particularly tough negotiation he and his partner were having with their principal lender. The pension fund was insisting on onerous security terms that would have meant the developers were personally liable for up to $50 million if the project failed. After protracted haggling over recourse language, the developers reluctantly agreed to be on the hook for $20 million but wouldn’t go higher. The Lender stood firm at $50 million. The whole deal was in danger of crashing.“Wait a second,” the developer said in a private conversation with his partner. “Are we worth $20 million?”

Nowhere near it, came the reply.“Fine,” said the developer.“If we’re going bankrupt anyway,we might as well agree to$50million.”Once you’ve won—or lost—on broader issues of principle,it’s easy to fall into the trap of quibbling over moot details.After the developers conceded on the matter of personal recourse, the extent of their potential liability didn’t matter much.

5. Negotiate the relationship

Ideally, carefully chosen contract language fosters better deals and stronger relationships. Stating that goal is one thing, achieving it another.You know what you intended to say in your proposal, but your counterpart may not read it that way. Even if her redraft doesn’t seem sinister on the surface, you may wonder what’s lurking between the lines.

Your resulting defensiveness won’t help matters.

Consider that negotiation affects relationships in two parallel ways.On a substantive plane, it defines future rights and responsibilities—which can raise fundamental issues of identity, fairness, and respect. Equally important is the process used.When a long-term relationship is in the offing,the negotiation itself is a trial marriage. For better or worse,parties glimpse how well they’ll collaborate in the future—and reflect this understanding in their formal agreement.

Sometimes the whole point of an agreement is to define a new relationship, such as the establishment of a business partnership. In such cases, it’s important to face tough issues squarely rather than sweeping matters such as profit sharing, decision rights, and possible dissolution under the rug. But when you bargain too hard in the pursuit of self interest,the relationship may be doomed from the start.Ideally, the process of negotiating terms and conditions should be one of mutual learning in which parties anticipate problems before resources are wasted or tempers flare.As newsletter contributors David A. Lax and James K. Sebenius note in their book 3-D Negotiation: Powerful Tools to Change the Game in Your Most Important Deals, the best contracts are those that are signed, filed away, and never looked at again.Candor, patience, and open-mindedness in the course of negotiation help foster such healthy working relationships.

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