Engagement Letter: Definition, Overview & Example

KEY TAKEAWAYS

• An engagement letter is an informal contract that is written between a client and a company. 
• The letter is used to describe the business relationship that is about to be entered between the two parties.
• Engagement letters are regularly used for a wide range of business negotiations and needs.

What Is an Engagement Letter?

An engagement letter is a written agreement between a company and a client. It describes the business relationship that is to be entered into between these two parties. The letter will contain details about the scope of the agreement, its costs, and the terms. The main aim of an engagement letter is to set the general expectations for both sides of the agreement. 

How Does an Engagement Letter Work?

An engagement letter works with the same purpose as a traditional contract between two separate parties. Its format is generally less formal than a contract and avoids the typical legal jargon that most contracts have. 

The letter is written to accurately but briefly describe the following:

• The services
• The deadlines
• The terms and conditions
• The compensation

While this letter is less formal than a contract, it is still a legal document. Meaning that in the case of a business deal, the information contained within the letter is binding. 

Essential Elements of an Engagement Letter

The essential elements of an engagement letter are as follows:

• Identification of both parties
• The scope of services
• The period of engagement
• The fee structure
• Responsibilities of each party
• Professional standards
• Confirmation of terms and conditions

Importance of an Engagement Letter

There are a number of important elements of an engagement letter that benefit both parties. Here are some of the key ones:

• They help you to set and keep track of expectations
• They reduce the chance of scope creep occurring
• They reduce risk for both parties

Advantages of an Engagement Letter

There are a number of benefits of engagement letters. When entering into a relationship between a client and a business, it is important to set expectations. 

The business has the advantage of being able to set the boundaries under which they’ll be expected to work and what will be expected of them in terms of performance. This helps avoid what’s known as a “scope creep”. This is where the scope of the project incrementally becomes larger and larger, leading to a number of potential issues on both sides. 

The letter can also cite any services that lie outside of the current agreement but could in theory be added in the future as needed. This will come with an estimate of the cost of these additional services. 

When it comes to the client, they benefit from the added layer of reassurance of knowing when the service will be completed and have a record of how much it will cost. The engagement letter also clears up whether any other costs are involved that are not covered in the initial agreement. An example of this may be additional software that has to be purchased separately by the client. 

An engagement can also include a clause around mediation or binding arbitration for the relationship. This aims to provide guidance for managing any disputes that may arise throughout the process between the two parties. 

If the relationship in question is long-term, many businesses will require that their engagement letter is updated and signed again by the client on a regular basis. This can be quarterly, every six months, or most commonly on an annual basis. 

This clause allows for any changes that occur in the business relationship over time. It also strengthens the legality of the document. It can also remind both parties about the scope of the agreement.

Standard Format of an Engagement Letter

Each engagement letter will of course be unique to the two parties in question. However, they will all tend to follow a similar format. The typical engagement letter format is as follows:

Parties

The letter will start by stating the parties relevant to the agreement. In most cases, one party will be the client, and the other party will be the business. 

Type of Service

Here you will outline the exact type of service that is being provided by the business to the client.

Service Details

This section is used to go into specific detail about the service terms that will be provided. This is an important part of the document in the bid to avoid any misunderstandings. It helps to set clear expectations regarding what will take place and the standard of the work. 

This section will also commonly outline the deadline or deadlines for the work, as well as the structure of the fee.

Joint Responsibilities

Here you will lay out the responsibilities that have to be carried out by both parties when the work is being undertaken. 

Disclaimer

The disclaimer section is where you will outline the scope of the service being provided. It is used to emphasize the limitations of the service and show any caveats with which the final result must be viewed. 

Validity and Termination

This section is used to lay out the period of engagement at which the agreement will be valid, or perhaps when the service is fully completed. The termination section will state the reasons why the agreement may be considered terminated and outline how to exit the engagement. 

Summary

Effective engagement letters are a great way for companies and clients to reach an agreement and protect themselves. 

The information detailed in the letter can be used to create expectations throughout the engagement process, as well as settle on the price and settle on the exact services that will be provided. 

Written by Grant Gullekson

Grant Gullekson is a CPA with over a decade of experience working with small owner/operated corporations, entrepreneurs, and tradespeople. He specializes in transitioning traditional bookkeeping into an efficient online platform that makes preparing financial statements and filing tax returns a breeze. In his freetime, you’ll find Grant hiking and sailing in beautiful British Columbia. Learn more about Grant’s services at viccityaccountant.com.

Written by Grant Gullekson

Grant Gullekson is a CPA with over a decade of experience working with small owner/operated corporations, entrepreneurs, and tradespeople. He specializes in transitioning traditional bookkeeping into an efficient online platform that makes preparing financial statements and filing tax returns a breeze. In his freetime, you’ll find Grant hiking and sailing in beautiful British Columbia. Learn more about Grant’s services at viccityaccountant.com.