Beginner’s guide to a profit sharing agreement

More brains are better than one, aren’t they? Business owners who collaborate and innovate alongside other business experts have reaped the benefits of joining forces, whilst remaining separate entities. To manage these relations, a profit sharing agreement can come into use. To learn what a profit sharing agreement involves, keep reading this Business Kitz blog post!

What is a profit sharing agreement?

A profit sharing agreement is a legally-binding contract which outlines the terms of how you will divide the profits from your joint venture. We see these documents created and implemented when two separate companies embark on an unincorporated joint venture. Thus, while these companies remain distinctly separate, they work together to complete a project or deliver a service. However, it is essential to ensure the profits are fairly distributed, and the details of the distribution are agreed upon and recorded in writing to protect both parties, via a profit sharing agreement.

When forming this contract, parties should engage in negotiation, record the details of the agreements and sign all necessary documents 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 has been 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 relationship of two or more parties where everyone agrees to split the profits for a period of time.

What is an example of a profit sharing agreement?

Let’s say you have started a health food business, but you want 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 then 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 of how the profits will be devised (usually represented as 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 disputes arise 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 as a resort if an issue arises.

Is this the same as a partnership agreement?

A partnership agreement is a legal relationship between two or more parties, with the intention of carrying on a business together. This is distinct from a profit sharing agreement which facilitates two businesses wishing to collaborate on a business project together , but remain separate companies. 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. Business Kitz have a number of agreements available via our subscription service! If you require advice on negotiating agreements, our sister company, Legal Kitz is here to help! You can book a free 30-minute consultation with their experienced and highly qualified team via our website now.

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