A profit share agreement, sometimes called a profit share contract, is an important legal contract between two or more parties, such as individual business partners, businesses, employers and employees, or investors and entrepreneurs. A profit share agreement is particularly important when two parties agree to undertake a joint venture as partners without creating a formal business entity, such as a C Corporation or Limited Liability Company (LLC).
The agreement states how profits generated through a shared effort or project will be divided. It also details the responsibilities of each party and describes the contributions each will make. The division of profits normally is based on the contributions of each party, whether those contributions are money, expertise, property, equipment, special knowledge, labor, or something else.
Let’s have a closer look at how profit share agreements work, what they should include, and who may benefit from using one.
Why a Profit Share Agreement is Important
Imagine a scenario in which two friends decided to take on a large landscaping project. They had been cutting grass, trimming bushes, and providing other yard care services together on an informal, part-time basis since high school, and felt they could take on the job, which included installing a flagstone pathway, building several stone planters, planting trees and shrubs, mulching, and constructing a wooden fence around the property. Without giving much thought as to how responsibilities and profits will be divided, they agreed to order the materials and start the work the following week.
It happens that Carlos owned a lot more equipment than Mark and had a truck they would both need to use for work. They put in about the same number of hours, although Mark sometimes needed to take time off to care for his young daughter.
Everything was going fine until it became clear that Mark expected to share the profits they’d generated evenly, despite Carlos having worked more hours and contributed more to the business in terms of equipment. Carlos strongly protested, Mark pushed back, and suddenly, their business enterprise was in jeopardy.
You can imagine the results of such a misunderstanding and how they could negatively impact a business venture, as well as the relationship Mark and Carlos had shared. Without a legal agreement spelling out the terms of what each would contribute and how profits would be divided, however, they were left to figure it out without any clear direction.
A well-thought-out and crafted profit share agreement puts everyone on the same page and helps to avoid conflict and misunderstanding like what occurred between Carlos and Mark. It addresses the specific roles of everyone involved, what each party will contribute up front and ongoing, and how profits will be earned and divided. This helps ensure that each party will receive a fair share of profits, based on their contributions.
What to Include in a Profit Share Agreement
The contents of a profit share agreement will vary depending on circumstances, the number of parties involved, how evenly contributions are made, the scope of the undertaking, and other factors.
There are some common elements, however, that should be included in profit share agreements, including the following:
- Legal names – The names and addresses of all parties to be included in the agreement should be stated, regardless of the scope of their involvement in the project.
- Timing – State the date on which the agreement takes effect and how long it will remain in effect, such as indefinitely or until the completion of a project.
- Project description – Include the nature and scope of the project you’re undertaking.
- Responsibilities and obligations – Describe what each party will contribute in terms of cash investments, expertise, time, and assets; shared and individual responsibilities of each party; how each party is expected to perform; and other applicable terms.
- Profit distributions – Establish exactly how profits will be determined and divided among parties, as well as how often distributions will be made.
- Losses – Specify how any losses would be handled and the responsibilities that each party would bear.
- Data constraints – State how confidential information such as sensitive data or trade secrets will be handled and the duration for which the confidentiality agreement will remain in place.
- Non-compete statement – Many, but not all profit share agreements include a clause stating that none of the parties included will collaborate with a competitor.
- Dispute resolution – Describe what steps the parties will take to resolve any disputes that arise, such as arbitration or mediation.
- Termination of the agreement – Explain how the agreement can be terminated and the rights of all parties resolved once it’s no longer in effect. Address what happens if one party wants to be excluded from the agreement, establishing terms for how that situation would be handled.
- Signatures – Each party will need to sign and date the agreement to make sure it’s finalized and legally binding.
When to Use a Profit Share Agreement
A profit share agreement is applicable in a number of situations, including the following:
- Employee compensation – Some companies use profit sharing to attract, retain, and motivate employees. A profit share agreement would spell out the terms of how profits would be divided and include other information, as described earlier.
- Joint projects – Individuals joining together on a project can use a profit share agreement to spell out what each party will contribute and how they will profit.
- Small businesses – A contract outlining the division of profits is important in a small company, as it holds team members accountable and encourages fairness among all involved.
- Family businesses – Employees in a family business sometimes assume the business will run smoothly because they’re working with family members, but that’s not always the case. Having an agreement in place puts everyone on the same page and can help to avoid conflict.
- Growing startups – As a startup grows and changes, it’s important to have a mutually understood plan for the roles and responsibilities of each team member and the share of profits each person will receive.
- Investments – Profit sharing can motivate someone who’s considering investing, as it’s clear there will be rewards for their contributions.
Final Thoughts
You’ve already read how profit share agreements can benefit individuals, teams, and businesses, but to recap, one of the primary advantages of this type of contract is that it promotes fairness and assures participants that they’ll be treated equally. It also sets expectations for everyone involved and clarifies what each party is expected to contribute, thereby holding people accountable.
You can find templates for profit share agreements online. If you choose to use one, consider having it professionally reviewed before making it official. Or you could assure yourself of getting the agreement that’s best for you by having a lawyer or other professional draft something that’s tailored to your particular situation.
