Warren Buffett bought this business with a handshake

Warren Buffett bought a business for $60,000,000 with a one page contract and a handshake.

No lawyers. No inventory audits. No digging into the books.

The seller’s reputation told him what he needed to know. Rose Blumkin, better known as Mrs B, lived by simple rules:

‘Sell cheap and tell the truth, don’t cheat nobody, and don’t take no kickbacks.’

The 89-year old Russian immigrant was a thorn in her competitors’ sides. She knew her business like the back of her hand, having worked with her mother since she was six years old. Her rivals sued her over low prices. In return, she framed newspaper clippings every time they went out of business.

Mrs B’s reputation told Buffett he could trust her. And when there’s trust, even a $60m transaction can be boiled down to a single page.

I was one of three cofounders at my last startup. We had a simple, signed agreement which outlined how many shares we owned and the vesting schedule. It took less than an hour to decide to split our shares 40-30-30 in favour of the CEO, and we never felt the need to change it.

Although our discussions went well, I was on the lookout for two red flags: either party wanting a highly-detailed contract, or my cofounders rejecting the need for a contract outright.

Both signal a lack of trust and in a stressful environment like a startup, you have to believe that whatever disagreements crop up (and there will be many: co-founder issues cause two out of three startup failures), you’ll treat each other fairly. Without trust, you’re dead in the water.

But if you trust each other, why are contracts necessary? Because bad incentives make good people do bad things, and because what’s best for the company isn’t always aligned with what’s best for the individual.

Contracts offer protection and clarity. They help to make sure everyone understands their roles, responsibilities and expectations, and provide a legal basis for moving forward if those aren’t met.

Back to red flag number one: long contracts.

If contracts are good, shouldn’t a detailed contract that covers every situation under the sun be even better?

Aside from signalling a lack of trust between parties, complex contracts increase legal fees, take longer, are more difficult to understand and make it harder to resolve conflict because they lock you into rigid positions. This last one is a killer when one of the advantages startups have over incumbents is adapting on the fly. Added to this, detailed contracts may actually be harder to enforce than simple ones, as even minor deviations from what’s described could cause a lengthy (and costly) legal debate.

Warren Buffett bought a $60m business with a single page agreement. You don’t need a contract as thick as an encyclopaedia for a company with no product, customers or revenue.

On the other hand, if your cofounders turn their nose up at the very thought of a contract, then something may be fishy. They might not be thinking about screwing you over, but the absence of a contract certainly makes it easier. With so many good reasons to draw up a brief agreement and no negatives, I’d certainly question their reluctance.

Watch out for excuses like not wanting to slow the company down or unnecessary costs (free online templates solve these), stories about how their friend’s cousin couldn’t enforce a contract (the exception, not the rule), or the awkward ‘I trust you so we don’t need one. Don’t you trust me?’

Contracts don’t replace trust, they supplement it. They provide assurances, clarity and improve decision making. What’s more, if you’re aiming to raise investment, VCs will expect contracts with vesting schedules in place to protect against a cofounder leaving early on with half the company’s equity in their pockets.

If none of these points land and you reach an impasse, I’d question whether these cofounders are right for you. In your shoes, I’d lean towards walking away. You can’t go all in when you have even the slightest worry in the back of your mind that you’re unprotected. Do you want to spend years of your life and vital energy building a company only to see it collapse because you didn’t have a one-page agreement?

You need to trust your cofounders, but more importantly you need to trust yourself. If your spidey senses are tingling, get out.

If you’d like to get advice on talking to your cofounders from someone who’s been there, book a paid call with me and we’ll get you on the right track.

I’m also running PitchPerfect calls, where I work with founders one-on-one to help them create a deck with a compelling narrative that gets investors’ attention. Take a look if you’re fundraising.

Speak soon,

Nelson