Outsourced business functions are governed by service agreements. These agreements are contracts between businesses and independent service providers. Like all business contracts, service agreements must be carefully written to ensure effectiveness, accountability, and legal protection. Service companies usually provide standard agreements, but since they tend to favor the provider, small businesses should review and modify an agreement with the assistance of their legal counsel before signing it.
Common Areas for Outsourcing
Small business owners often prefer to keep money inside their business and do things themselves. But economies of scale in a global marketplace have made it necessary for many small businesses to take a page from the playbook of larger companies and outsource some functions.
Outsourcing statistics indicate that approximately two-thirds of companies with fifty or more employees outsource, as compared to around one-third of businesses with fewer than fifty employees. Roughly half of all small businesses say they plan to outsource business processes in the future. The most commonly cited reasons for small business outsourcing are increased efficiency, expert assistance, and freeing up employees to do other tasks.
The functions most likely to be outsourced are noncore functions. Deloitte notes that small- to medium-sized companies lack the office space or budget for in-house departments that handle functions such as finance and payroll. Small businesses most often outsource technical tasks like accounting and information technology (IT) services. They may also choose to outsource the following roles:
- Human resources
- Customer service
- Invoices and billing
- Administration (i.e., virtual assistants)
- Shipping and logistics
- Property management
- Legal services
- Consulting services
- Large or complex projects that fall outside a company’s core functions
Due to technology and the increased prevalence of remote work, almost any aspect of a business can be outsourced these days. It is even possible to outsource a company’s C-suite executives, such as a chief financial officer (CFO), chief marketing officer (CMO), and chief technology officer (CTO).
Important Provisions in a Service Agreement
A services partnership is only as strong as the agreement underlying it. Service agreements have much in common with standard business contracts. Among other points, they should identify the parties to the contract, the contract’s duration, the responsibilities of each party, and mechanisms for resolving disputes. The following additional provisions should also be addressed:
- A description of the work to be performed (as well as what is excluded)
- Duration of the contract
- Expected service levels
- Performance benchmarks
- Reporting processes and methodologies for verifying service levels
- Standards for each level of service (for example, an IT services provider may offer prime-time services with higher service levels during working hours and nonprime after-hours service with lower service levels)
- The compensation to be paid to the provider, the manner of payment, and the frequency of payment
- The circumstances that entitle either party to cancel the agreement
- Noncompete and nonsolicitation covenants
- Confidentiality and nondisclosure covenants
- Indemnification (i.e., the business is legally protected from the actions of the service provider); depending on the contract, this may be applicable to both parties
- Remedies and penalties for a breach of the contract
- Dispute resolution process (e.g., arbitration)
- Liability for attorney’s fees
Other Considerations for Service Agreements
Any contract you enter into with a service provider needs to be well thought out. Service agreements should align with your company’s broader business aims, set clear expectations and goals for contractors, and include precise definitions of key terms and concepts. Here are some points to keep in mind as you negotiate a service agreement:
- Be mindful of metrics. You should have standards and processes in place to measure a vendor’s performance. The service provider should make relevant statistics available to you. This is typically done through an online portal. Failure to meet service levels can entitle you to service credits or trigger a vendor penalty, depending on the contract’s Performance metrics vary based on the services provided. Keep the metrics as simple as possible to make monitoring effective, and include a contractual protocol for adding and removing metrics. Examples of metrics include service availability, defect rates, security measures, and key performance indicators.
- Make sure to vet partners. A strong contract that protects your interests is essential, but if you get involved with a service provider that does not uphold their end of the bargain, you will still experience Working with a known and proven service provider—especially one that has a record of success in your industry—will go a long way. Awards or certificates are a good sign of trustworthiness, although you should also make sure they are a good fit for your business. Identify your requirements and expectations before entering into a contract and look for providers that check the boxes that are important to you.
- Leave room for changes. Your service contracts should be adequately flexible to accommodate changes that arise during the course of a business relationship. It is not necessary to scrap the entire contract and start over when the need for revisions crop up. You can facilitate changes to the contract by including a mechanism for making required updates.
- Employee or contractor. The flexibility and cost savings of hiring a contractor could be undermined if you get drawn into a dispute about whether the person you hire is actually a contractor. Federal and state rules about worker classification (employee or contractor) are complex. The bottom line is that if you dictate every aspect of how a provider renders services, it could cross the independent contractor line and enter employer-employee territory. You can avoid this by clearly establishing contractor status in your service
Well-written service agreements set clear expectations for both parties and are the foundation of a strong business relationship. A service provider may have a standard contract, but you should not sign it without first reviewing it with a business attorney. Our law office helps small businesses with all aspects of business contracts, from reviewing and drafting to enforcement and dispute resolution. To schedule an appointment with our team, please contact us.