What is Consideration in Contract Law?

You are likely staring at a contract right now or will be soon. The legal jargon can feel dense and impenetrable. Founders often worry about hidden clauses or complex liability structures. However, the validity of the entire document often rests on a very simple concept.

That concept is consideration.

It is the engine that makes a contract go. Without it, you do not have a legally binding agreement. You simply have a promise or a gift. Neither of those will hold up in court when a partnership sours or a vendor dispute arises.

Understanding this term helps you strip away the legal fluff and look at the mechanics of your agreements. It forces you to ask the right questions about who is giving what and who is getting what.

In the context of business law, consideration refers to the benefit that each party gets or expects to get from a contractual deal. It is the concept of quid pro quo, or something for something.

For a contract to be enforceable, there must be mutuality. One party offers something of value, and the other party accepts it in exchange for something else of value.

In a startup context, this usually looks like:

• Money exchanged for software development services.
• Equity exchanged for intellectual property assignment.
• A salary exchanged for an employee’s time and non-compete agreement.

Consideration does not necessarily have to be money. It can be a promise to do something you are not legally obligated to do. It can also be a promise to refrain from doing something you have a legal right to do.

This is where early-stage startups often run into trouble. You might have a friend who offers to help with some code or marketing “for free” because they believe in your vision.

If you write up a document stating they will provide this help, but you do not offer anything in return, that document may not be enforceable. This is because there is a lack of consideration on your side.

This becomes critical regarding Intellectual Property (IP). If that friend invents a core feature and later claims ownership, a contract assigning that IP to your company might be void if you gave them nothing in return.

To fix this, contracts often include nominal consideration. You might see phrases like “for the sum of $1.00 and other good and valuable consideration.” This is an attempt to satisfy the legal requirement that a value exchange took place, even if the value is small.

One specific area that trips up founders is the concept of past consideration. This occurs when you try to create a contract based on an action that has already happened.

Imagine a scenario where a co-founder worked for free for six months. You incorporate today and sign a contract granting them equity for the work they did last year.

Legally, the work done in the past might not be valid consideration for the new promise of equity. The exchange needs to be bargained for in the present.

This raises difficult questions for your team:

• Are we formalizing agreements for work that hasn’t happened yet?
• If we are compensating for past work, have we structured the current agreement to include new obligations to ensure it is binding?

As you build your operations, look for consideration in these common documents:

• Modifying Contracts: If you change an existing contract, you generally need new consideration. You cannot simply demand more from a vendor without offering something additional in return.
• Settlement Agreements: If you are settling a dispute, the consideration is usually the agreement to drop a lawsuit in exchange for payment.

When reviewing any document, look for the exchange. If you cannot clearly identify what both sides are losing or gaining, you may have a validity problem.