When you team up with other businesses to start a new venture, you’re hoping to maximize profits––and reduce your tax liabilities. But how do you determine how profits are allocated? And how do you ensure that your profit share is fair based on what you’re bringing to the table? Well, as our attorneys will explain, it all starts with a profit sharing agreement––let’s consider how they work.
What Is a Profit Sharing Agreement?
A profit sharing agreement sets out how businesses will share profits when they come together to start a new venture. These types of agreements allow businesses to remain separate entities but join forces for a shared purpose.
How Do Profit Sharing Agreements Work?
The premise is simple.
- Each business commits assets, money, and/or property to the venture. Special knowledge and skills may be factored in as well.
- In exchange, each business should receive a profit share that reflects what they bring to the agreement and the risks they’re taking on. So, the more duties you take on, or the more capital you provide, the higher your profit share should be.
- Profit sharing agreements should also specify how losses are managed, and what rights each party has to claim damages from the other party if anything goes wrong.
- The agreement should set out how profits are taxed, and how tax responsibilities are divided between parties.
- There must also be a clear exit strategy for bringing the agreement to a close once the project is complete.
Profit Sharing Agreements vs. Profits Interest Agreements
It’s common to confuse profit sharing agreements with profits interest agreements, but they are completely different.
- Profit sharing agreements give parties the right to share the profits of a venture or project they embark upon together. There’s no right to profits generated by the business more generally, and the agreement doesn’t give you any equity or ownership interest in the other company.
- Profits interest agreements, on the other hand, give parties the right to a share of the company’s future value. It’s a type of equity compensation and it’s often used to reward or incentivize employees.
Profit Sharing Agreements vs. Partnership Agreements
Similarly, profit sharing agreements are not the same as partnership agreements.
- A profit sharing agreement sets out the terms for embarking on a shared project, initiative, or venture. It does not imply that you are carrying on a business together. The agreement only lasts for the duration of the project.
- A partnership agreement allows you to form a partnership, which is a type of business structure, with one or more other parties. Partnerships go beyond one-off ventures and they can last indefinitely––or at least until one party wishes to dissolve the partnership.
So, with all that in mind, who needs a profit sharing agreement? Let’s take a look.
Who Needs a Profit Sharing Agreement?
You should strongly consider a profit sharing agreement if you’re working alongside another business to achieve any of the following goals:
- Collaborate on a project
- Undertake a joint venture
- Deliver a new product
- Offer a new service
Essentially, if you’re working alongside another business, but your businesses will remain separate entities, then you could benefit from a profit sharing agreement for the venture.
Unsure if you need a profit sharing agreement for your business? The Gordon Law team can help.
Are Profit Sharing Agreements Legally Binding?
Yes. Profit sharing agreements are legally enforceable as long as there are no major issues with the contract, such as misrepresentation or failing to disclose something material prior to entering the contract.
To ensure that your contract is valid and legally enforceable, consider hiring a contract lawyer rather than using a template.
Benefits of a Profit Sharing Agreement for Businesses
Still not sure if you need a profit sharing agreement for your next business venture? Let’s consider some of the key benefits of drafting an agreement on profit sharing.
- Fairness: A profit sharing agreement, when drafted effectively, ensures that each party gets a fair profit share based on what they’re bringing to the venture. This reflects the risks each party takes when taking on the project.
- Clarity: Your contract provides a clear framework for what’s expected of each party. This ensures that everyone is on the same page.
- Certainty: You will benefit from peace of mind when you know precisely how profits are divided and how disputes are resolved.
What to Include in a Profit Sharing Agreement for Your Business
Just as every project or venture is different, there’s no such thing as a “standard” profit share agreement. However, every business profit sharing agreement should cover, at a minimum, the following areas:
- Rights and Obligations: Your agreement should establish what’s expected of you––and what legal rights you have under the contract.
- Liabilities: You should limit what you can be held liable for, and the extent of any damages the other party can claim if something goes wrong during the project.
- Profit Distribution: Clearly establish how profits will be calculated and distributed and how often profits are distributed. Consider hiring a tax professional to minimize your resulting taxes. With Gordon Law, you have both contract law and tax law covered under one roof.
- Termination: Determine when you can dissolve the agreement without penalty e.g. if there’s a breach of contract. And set out conditions for bringing the agreement to its natural end.
- Dispute Resolution: Agree how disputes should be resolved; for example, by arbitration or mediation. It’s also helpful to confirm which state or national laws govern the agreement, especially if you’re located in different jurisdictions.
- Confidentiality: Confirm how you’ll handle confidential information, such as trade secrets, and how long confidentiality obligations will last for.
- Intellectual Property: Be clear about who owns what intellectual property e.g. trademarks created during the agreement. Set rules for how to enforce and protect these property rights.
Don’t let profit sharing agreements overwhelm you! Although they’re complex, we’re here to help, so don’t hesitate to reach out if you need a little guidance.
Do You Need a Lawyer to Draft a Business Profit Sharing Agreement?
Well, technically there’s no requirement for a lawyer to draft a profit sharing agreement for businesses. But remember: a profit sharing agreement is a legally binding contract. Without legal advice, you risk:
- Receiving a lower profit share than you deserve
- Lack of protection if key terms and conditions are not included in the contract
- Facing serious difficulties if you want to end the contract early
To ensure that your commercial interests are protected, it’s best to seek legal advice from experienced contract attorneys prior to signing an agreement.
Unsure How to Write a Profit Sharing Agreement for Your Business? Contact Gordon Law!
An effective profit sharing agreement is key to any successful business venture. However, at Gordon Law, we know just how difficult these contracts are to get right. That’s why we’re on hand, ready to assist if you need us. With over 10 years’ experience in successfully handling contract issues, we can help you avoid potential pitfalls, advise you on how to maximize your profits, and support you if disputes arise.
Don’t let business profit sharing agreements overwhelm you. Get the legal assistance you deserve from the team at Gordon Law. Give us a call or schedule a consultation online to learn more about how we can help!
