A profit sharing agreement can help business owners commonly collaborate with other businesses to achieve the same purpose. This is commonly referred to as an unincorporated joint venture, where the two entities remain separate companies but work together to complete projects or deliver a new product or service. In these circumstances, you may also want to split the profits that you generate from these great collaboration opportunities. In that case, you will want to ensure that the distribution of profits is agreed upon and recorded in writing to avoid any disputes in the future. This is exactly what a profit-sharing agreement is for. Legal Kitz will take you through what a profit sharing agreement should contain.
What is a profit sharing agreement?
A profit sharing agreement is a legally-binding contract which outlines the terms of your profit sharing arrangement. When forming this contract, parties should engage in negotiation, record the agreements and sign the document before they enter into a partnership project. This negotiation will factor in the different skills and capabilities that each business is bringing to the project. Once an agreement is reached, the division of profits will most likely reflect this split in responsibilities, contributions and risks between each organisation. For instance, a business with more intensive duties with greater risks may negotiate for a high-profit margin under the agreement.
These types of contracts may also be used in employment, independent contractor situations or any other business relationships of two or more parties where everyone agrees to split the profits for a period of time.
Example
Imagine that you begin a health food business, but you wish to build your customer base so you can put your products in local health food stores. You may enlist the services and marketing of a famous athlete to help make some new dishes with you, and appear in the marketing campaign. Both parties in this situation may agree that the profits be shared, with the business owner getting 85% and the athlete getting 15%. This should be clearly documented and signed in a profit sharing agreement to protect both parties’ interests.
What should a profit sharing agreement contain?
A profit-sharing agreement will typically contain the following clauses:
1. Profit sharing
As expected, the contract must have a clear provision that document’s the division of profits (usually represented with a percentage). This will need to detail:
- How you will calculate the profit;
- The timeframe in which you will be sharing profits; and
- When the secondary party will be expecting to receive their profits.
2. Termination
There will typically be clauses that outline situations where a party can terminate the profit sharing agreement and how to formally terminate the contract.
3. Dispute resolution clause
If any dispute arises between the parties to the profit-sharing agreement, a dispute resolution clause is an effective safeguard to bring both parties together to discuss a disputing matter before one party makes a claim. This can ensure both parties act in good faith, but may also mitigate the risk of a prolonged dispute or costly legal fees from pursuing a claim against one another.
4. Confidentiality
Both parties should agree to uphold full confidentiality regarding the profit-sharing agreement and its terms. Note that this clause will usually remain ongoing and survive beyond the termination of the contract.
5. Obligations
There should be multiple clauses outlining what each party agrees to provide as part of their collaboration on the project. These might arise from the negotiation process but are important to document so that each party is obligated to deliver their responsibilities and services to the project with skill and care.
6. Intellectual property
Through collaborating on a common project, parties may share or offer access to using their intellectual property. A clause outlining this arrangement is vital to consider who has ownership over the intellectual property and what happens to any intellectual property that is created during the course of the project.
7. Indemnities and liabilities
Indemnity and liability clauses are important in most contracts to outline the extent of each party being liable if certain issues arise. A party may also agree to indemnify the other party in these situations and this should be clearly documented to rely on if an issue arises.
Is this the same as a partnership agreement?
A partnership agreement is a legal relationship between two or more, with the view of carrying on a business together. This is distinct from a profit-sharing agreement which facilitates two businesses wishing to carry on a business project together whilst remaining separate entities. A profit-sharing agreement will usually only last for the duration of that specific project whereas a partnership agreement will last for the foreseeable future until the partnership is dissolved.
Legal advice
If your business is looking to form a joint venture or project alongside another business, it is recommended that you implement a profit-sharing agreement. Distinct from a partnership agreement, this legally binding contract allows a business to work with another separate entity on a common project whilst receiving a division of profits from that collaboration. Outlining the duties, obligations, distributions and profits, this form of agreement will safeguard your business to embark on collaborative ventures and innovative goals using the strengths and services of another organisation alongside your own. Legal Kitz can assist you in drafting a profit sharing agreement. Book here now for a FREE 30-minute consultation.