Ironclad Contracts: Tougher Than a Pinky Swear
Published: February 8, 2010
You’ve passed the seduction phase. You’ve made the client fall in love with you. You’ve determined the terms of your engagement. Now, you need to make things official.
When I used to do freelance on the side, while still employed full time, I never got my clients to sign contracts. I didn’t see the point, and I hated the formality. It felt stuffy, and I thought it would be a turnoff to my clients. Instead, I outlined a loose schedule and process in an email message, told them the dollar amount, then got to work while I waited for the check. If I didn’t get things done on time, it was no big deal, because my clients’ expectations of my commitment were pretty low. If the check came later than I was hoping, that was no big deal either, because I had my salary to rely on. All in all, everything was fine.
But once I quit my job to do consulting full time, all of that easy, breezy stuff had to change. I needed protection. And so did my clients.
I’m going to tell you right now, the legal part of consulting isn’t fun. All of the good will you’ve built up with your prospective clients during the getting-to-know-you phase is going to be tested. It’s entirely possible your budding relationships won’t make it. Sometimes people get touchy about the details, and seeing them all on paper can make people uncomfortable. You’re essentially asking your fiancée for a pre-nup. It’s going to be tough, but trust me, it will be worth it.
Everything you figured out during your scope-definition process lays the groundwork for the terms of your contract: the activities you’ll be conducting, deliverables you’ll be producing, your intended schedule, costs. But there are some crucial elements you and your client still need to agree on: payment structure, payment schedule, overage policy, change request policy, and the dreaded termination agreement.
Hourly, Flat Rate, or Retainer Payment Structures
There are three main types of payment structures for a typical consulting agreement. I’ll talk about these separately from the payment schedule, because you can mix and match these, as appropriate. An hourly rate means you’ll be paid only for the hours you actually spend working on the project. A flat rate means you’ll be paid an exact, predetermined dollar amount, regardless of the time you spend working. And a retainer means you’ll be guaranteed either a certain number of hours or a certain dollar amount for a recurring period of time. I’ll explain each one in detail.
Working for an Hourly Rate
Ninety-nine percent of the time, with an hourly agreement, your client will expect you to estimate the total number of hours a project will take before the work even commences, so they can budget accordingly ahead of time. Few companies will commit to an hourly rate before understanding how much it’s going to add up to in the end. If your task is rote and you have a lot of experience doing it, estimating your future hours might be an easy thing to do. Also, if you take on multiple clients simultaneously, you may know exactly how many hours per week you intend to spend working for each one. Then you can multiply your weekly hours by the number of weeks in the project and voilà.
However you estimate the hours, you’re going to want to give yourself a buffer. The team you’re working with will make discoveries throughout the duration of the project that may grow or shrink its future undertakings, thus affecting your hourly commitment. You certainly don’t want to paint yourself into a corner by selling only the exact number of hours you think you’ll need to get the minimum amount of work done. Why assume the minimum?
Furthermore, you need to consider ahead of time what kinds of work you deserve to be paid for. There’s the obvious time for writing, drawing, and coding when you’re in the midst of creating your deliverables, but what about the reading time, learning time, and thinking time? If it’s required for the project, the client should be responsible for paying for it. Don’t make the mistake of estimating the smallest number of hours possible for achieving the task, then accruing far more work hours on your own dime. This is a business transaction, and neither party should be taken advantage of.
So, on the flip-side of that, be fair in presenting your estimate and indicate your margin of error. I would say that plus-or-minus 20% is fair, but this is something you’ll need to carefully negotiate with your client, and what is acceptable will largely depend on their internal budget. My point is that an hourly arrangement is by far the most risky, so be sure to put a safety net in place.
It can never be said too often: choose an hourly rate that is fair to you. Yes, geographic location does play a role in a client’s tolerance for a particular hourly wage. But don’t forget that you are a highly specialized practitioner who does great work and deserves to be paid amply for it. A common message in all of my words of advice is: don’t sell yourself short. Now’s the time to take that advice literally. And keep in mind that—for whatever strange reason—a higher hourly rate is a bigger turnoff to clients than a higher hourly estimate, so adjust your equation accordingly.
Working for a Flat Rate
Next, there is the flat-rate agreement. The number of hours you’ll need to commit to a project plays the largest role in determining your flat rate for the work—but with a lot more breathing room built into it. Personally, I prefer to charge for projects based on the amount of space they take up in my brain—as opposed to the amount of time they take up in my schedule. As a result, I very, very rarely agree to per-hour compensation. (Pretty much only when I’m completely in love with a project, and the client isn’t willing to do anything else.) As I say on my Web site, “I don’t measure the value of my work in the number of hours that I spend working; therefore, I don’t charge by the hour. If I take half as long as someone else to get things done, that doesn’t mean I’m half as good; on the flip side, if I take twice as long, you shouldn’t be penalized.”
As I described in detail in my recent column on scope, I prefer to work backward from a client’s budget. The project rate then helps determine: (1) the duration of the project; (2) the types of activities I’ll conduct; (3) the types of deliverables I’ll produce; and (4) how formal those deliverables must be. It’s the fourth point that really makes all the difference, so it’s necessary to clarify this with the client when determining the project cost. Two projects with the same duration, the same activities, and the same deliverables can cost two greatly different amounts based on the depth of information each deliverable contains—and, therefore, not only how much time you’ll need to spend on them, but more important, the amount of brain power it will require to complete them well. More brain power equals more money, right?
Working for a Retainer
Now, the last payment structure is the retainer. Working for a retainer is very common in some industries, but almost unheard of in others. Whether it’s a retainer based on hours or dollars, the concept is that your client is retaining your services for a guaranteed and predetermined amount of time or money. For example, 10 hours of work per week or $5,000 per month. Typically, your client would pay you up front for each period, and you’d do only as much work as the retainer allows. Of course, this never really happens. If you’re on an hourly retainer, you’re bound to exceed your hours—and your client likely won’t grant you more until the next period—so you can end up essentially working for free. With rate retainers, clients may expect you to do as much work as they want you to do, but for only the amount of money they’ve agreed to pay you. Of course, on the other hand, you might get away with doing considerably less during a given period than they’ve paid you for. Working on retainer is a gamble, but people who do it enjoy the steady income and the security of consistent work.
Up-front, Periodic, or Milestone Payment Schedules
Now that you and your client have figured out how you’re going to be paid, let’s figure out when. A couple of these payment plans are easy: If you’re getting paid by the hours you accrue, you won’t get paid up front, so you’re going to want to get paid what you’ve earned periodically. Biweekly payments are typical for salaried employees, but may be difficult to obtain for consultants, because not every company can get you on their payroll. You might have to settle for monthly payments, but I wouldn’t agree to much longer than that.
As I mentioned earlier, retainers typically get paid up front, but it’s up to you to determine how much up-front payment you want to request. If you’re going to stick to 10 hours a week, how many hours are you going to require the client to buy from you at a time? A block of four weeks or a whole year’s worth? I’ve heard of both happening. Every client’s expectations are different, so talk this through with your client, then get it in writing.
Companies can pay for flat-rate projects in all three ways: They can pay for them up front—as I often persuade my clients to do—either in part or in full. They can make payments periodically—for example, in thirds, equally spaced over the duration of a project. Or they can make partial payments as you complete each milestone—for example, 20% after the discovery phase, 30% after wireframes, 30% after visual design, and 20% at project completion. The higher the rate, the more likely a client is going to want to break up the payments over time. As I alluded to earlier, you can encourage your client to pay in bigger chunks by offering a discount on the total rate. Just make sure that the final price isn’t so low you’ll be bitter about it later.
Then, there’s the net question: How soon after you’ve invoiced a company must they pay you? I try to stick to net 30 days, which means I am due payment no more than 30 days after they have received my invoice. Some companies have a net-45 or net-60 policy, and I recently came across a company with a net-53 policy—that boggled my mind! Larger companies who commonly interact with contractors have such policies, so be sure to ask companies about them or ensure they’re willing to accept yours.
And if they don’t pay on time? Will you charge interest? After how long? And how much? I’ve asked around and found that 1.5% per month on the total unpaid amount is pretty typical. That extra amount isn’t going to make you a millionaire, but its being there in the contract will help if and when you need to enforce payment.
More or Different
How are you going to handle it when you end up spending significantly more time working on a project than you had anticipated, and you’re exceeding its budget? How are you going to react when clients change their mind midstream and decide they do want you to do that other thing after all or want another round of revisions on a document or need you to get it all done two months earlier?
You need to have a policy in place for handling changes. Even for a flat-rate agreement, I always make sure to calculate the absolute maximum number of hours I’m willing to work per week, per month, or total, and clearly state that number in the contract. Once a project exceeds that maximum, I charge overtime at a hefty hourly fee, also stating it clearly in the contract. It’s a great deterrent to a client who’s thinking of piling on more work, and it also helps with self-discipline, because you don’t really want to have to go there with your client. Still, it’s good to have the safeguard.
In the case of a client’s asking for additional work outside the original scope of a project, how much newness is enough to consider issuing a change request? How should you tack on the additional cost? In an even worse scenario, how should you remove no-longer-desired phases? Have these conversations with your clients ahead of time to make sure they understand the consequences of change and to avoid their otherwise inevitable assumptions about what’s included under the original contract.
Your Contract or Theirs
—them, of course!”
Every client is going to have a different policy for handling contracts. If you’re working with a small or a new organization, they may never have dealt with a consulting agreement before, so you’ll need to walk them through the process. On the other hand, if a company regularly works with consultants, they may have a standard independent contractor agreement (ICA) they’ll require you to sign.
I work with startups, small agencies, big agencies, and major corporations. The best generalization I can make is that startups and small agencies will be willing to sign your standard contract, while big agencies and major corporations will ask you to sign theirs. A few times, my clients have been willing to sign both. More often than not, my version of the contract focuses more on what I’m going to deliver, when, and for how much. A client’s contract is more about who owns what once the project is complete—them, of course!
Long or Short Contracts
There are several styles of contracts to consider. Because of my desire to remain casual, while still being professional, I typically use a one-page letter of agreement instead of a massive document like that an agency might require. The boilerplate for this letter of agreement—which I received from a friend who is also an independent consultant in UX—uses clear and formal language that outlines the services I’ll be providing, the start and end dates, the maximum number of hours I’ll spend on a project in total, the flat rate and expected dates of payment, and two signature lines—theirs and mine. For the majority of my projects, this simple contract has worked well in ensuring both of us are in agreement on the terms of the project and ready to commit.
Because of the obvious physical constraints of my one-pager, it doesn’t include a lot of detail. In fact, it doesn’t include some of the details I’ve just recommended. But its length is gradually growing. The breakdowns in communication I’ve had with clients have ultimately led to my adding more and more stuff to my contract. Over the course of a year and a half of consulting, there is one thing I have added that is more important than pretty much anything else in the entire contract: the termination clause.
A Horror Story
To make sure each and every one of you adds a termination clause to your contracts, I’m going to scare you into doing it by telling you the biggest contract failure I’ve had in my professional consulting career.
Last summer, I had an awesome, high-profile client, and I was loving the work I was doing for them. As is the case with many of my projects, a Web design agency subcontracted me to do the work. So in reality, the awesome, high-profile client was really the agency’s client, not mine. The agency was my client, and they had brought me in to supplement their existing team.
The super-cool company is a famous-person’s brand with a whole bunch of different properties across multiple industries. They hired my client, the agency, to redesign three of their Web sites and scheduled the projects to happen one right after the other. When the agency brought me on, we decided to figure out how much time I would be spending across all three projects, so I could charge a single flat rate. This was great for them, because it ensured they would own my time for many months to come. This was great for me, because it ensured I would be employed for many months to come—or so I thought.
Things were going pretty well on the project. I was enjoying what I was doing, and the agency was very happy with my work. However, for reasons I needn’t go into here, the super-cool company’s expectations were not being met, and the day after I had sent in the final version of my last deliverable for project 1, the agency informed me that my services were no longer needed for projects 2 and 3.
Putting aside the emotional distress of the situation, I needed to figure out how much money they owed me. The payment structure we had agreed to was a flat rate across all three projects. Although we had determined that flat rate based on an estimate of total hours and an hourly rate, ours was not an hourly agreement. The payment schedule we had agreed to was payment in equal thirds: one third up front, before the project started; another third paid exactly a third of the way through the project’s total duration; and the last third paid at the two-thirds mark. In other words, despite the three projects’ having different sizes and, consequently, different durations, we had treated all three projects as one in my contract.
My termination came one day after I had handed in the final deliverable for project 1 and exactly one week after I had sent in my invoice for the second payment. The agency informed me that, because the hours I had accrued on project 1 roughly equaled the amount of money they had paid me up front, they were not going to pay the second payment, for which I had just invoiced them. In fact, they weren’t going to pay me anything else at all.
The termination clause in our contract stated only that the contract was valid until 30 days after written termination. What it did not state was what penalty fee they would owe me in case of termination. That was my big mistake.
The agency argued that they had paid me for the hours I had worked. I felt they owed me additional compensation, because I had been expecting another two and a half months on the project—and two-thirds of my flat rate, so consequently, had been turning down dozens of prospective clients who wanted to work with me during that time. I argued that, at a minimum, they owed me payment for the 30 days our contract was still valid, because we had agreed on a project rate structure. They believed it was an hourly rate structure with a periodic payment schedule. Despite my having made the commitment to them, they weren’t willing to meet their commitment to me, and I was out on my ass. This issue still remains unresolved.
The Best Advice
I asked my Twitter followers for the greatest lessons they’ve learned when it comes to contracts, and I wholeheartedly agree with their advice. Here’s what they had to say about contracts:
- The obvious deserves to be stated: “Always have one, and you can never have too much detail,” says Matt Nish-Lapidus, formerly an independent consultant and now at nForm.
- Justin Davis of Madera Labs notes, “Any vagueness will bite you bad.”
- “Read them,” Livia Labate of Comcast Interactive Media quips. “Seriously, all the way through,” adds Jake McKee of Ant’s Eye View.
- “Ask when don’t understand something,” advises Jared Spool, founder and CEO of the consultancy User Interface Engineering.
- Independent consultant Kyle Soucy urges, “Don’t be afraid to push back.”
- Consultant Katherine Gray touched on my initial resistance: “Contracts preserve good relationships. Don’t skip them because you like the person and think nothing could go wrong.”
- And if my nightmare is any indication, Josh Evnin, consultant at ThoughtWorks, is right on: “Get a real lawyer to look over your standard contract. They’ll see all kinds of stuff you wouldn’t have.”