Does Your Partnership Need a Profit Share Agreement?
If you are conducting business with another person or people, a popular business structure is a partnership. A partnership agreement will generally govern key details of the partnership and contain terms as to the division of profits. However, your business might be more complex, or you and your partner wish to delve into greater detail about your profit-sharing arrangements. In that case, you can consider drafting a profit share agreement. This agreement is also useful when two unrelated parties collaborate on a specific project (rather than conducting an ongoing business together), known as a joint venture. This article will outline what a profit share agreement is and whether your business should have one.
What Is a Profit Share Agreement?
A profit share agreement is a contract between the partners that outlines how they will share profits. Both parties must negotiate the terms and be satisfied before signing the agreement. This agreement will contain several key terms, which are outlined below.
Profit-Sharing
Perhaps the most important term (at least from the parties’ perspectives), the agreement will need to contain provisions that outline how partners will share profits. Key considerations include:
- what the split is (i.e. a fixed percentage or KPI-based);
- how partners will calculate profit; and
- when profits will be distributed.
Dispute Resolution
During the life of your business, partners may disagree about the profit-sharing arrangement. Therefore it is essential to include a disputes resolution process. Hence, you and your partners will have a clear process to follow, making it more likely you can resolve your differences amicably. It is also essential to include information about what to do should this process fail.
Termination
The contract will usually contain a clause that outlines how each party can terminate the profit share agreement. The clause should also detail whether exercising this option will have any flow-on effects. For example, will one partner leaving result in the termination of the partnership or joint venture as a whole? These are issues you should discuss with your partner and include in the agreement.
Obligations
You can also include clauses that outline what each partner has promised to contribute to the arrangement, likewise, how these obligations will reflect their profit share. Such clauses are particularly important if you base the profit-sharing arrangement on performance rather than a fixed percentage. Ultimately, each party should promise to deliver their services with skill and care.
Confidentiality
Additionally, you and your partners may wish to keep the terms of the profit share agreement confidential. This is especially important if one or more partners is part of other businesses which operate in the same industry. Such a clause usually survives the termination of the agreement.
Do I Need a Profit Share Agreement?
Before you begin drafting a profit share agreement, it is crucial to ensure that your business will benefit from this document. There are several different business structures, and not all of them require profit share agreements. That is not to say that profit-sharing arrangements are undocumented in non-business partnership structures. The table below outlines when a business structure is a “business partnership” and, therefore, when you should consider this agreement.
Common Business Structures
| Business Structure | Definition | Business partnership? | When to find the profit share arrangement |
| Sole trader | An individual running a business | No | N/A |
| Partnership | Where two or more individuals run a business together to generate profit and share in the business’s income or losses | Yes | Partnership agreement or profit share agreement |
| Joint venture | Where two or more individuals or companies work together towards the same strategic goal. However, unlike a partnership, they all maintain their separate businesses while doing so, and the venture usually has a fixed end date. | Yes | Joint venture agreement or profit share agreement |
| Company | A separate legal entity registered with the Australian Securities and Investments Commission. A board of directors will run the company, and shareholders will own it. | No | Shareholders agreement and employment agreements |
| Trust | A relationship between the trustee and the beneficiaries | No | Trust deed |
Note that most of the business structures are not partnerships per say. However, if they collaborate with another entity or individual for a joint venture, they will be part of a business partnership and should have a profit share agreement.
Why Should I Have a Profit Share Agreement?
Whether you are part of a partnership or joint venture, there are several key reasons to implement a profit share agreement.
Partnership
| Clarity | Documenting the profit share arrangement ensures each partner is aware of their entitlements in the business from the beginning. |
| Dispute avoidance and resolution | Having a profit share agreement makes it less likely that a partner will raise a dispute about their share of partner profits. If they do, the document will contain a process to follow to ensure the partners attempt to resolve the dispute amicably, and will contain steps if that process fails. |
| Tax | Each partner’s profits will form part of their personal income tax. Hence, having this agreement in place means they can plan accordingly (e.g. by setting up a trust to account for extra income). |
Joint Venture
| Unrelated parties | The nature of a joint venture is two unrelated parties working in collaboration, meaning there may be a lack of trust regarding profit sharing. This makes it essential to have an agreement in place from the beginning to ensure each entity is on the same page regarding profits. |
| Contributions | Each party to a joint venture will likely bring different skills and capabilities to the relationship, and as a result, will contribute differently. It is important to reflect this in the profit-sharing agreement. |
| Time | A joint venture is for a predetermined purpose and has a fixed end date. Hence, it is important each entity knows how much they will be receiving for their time and contributions, as well as when they will be receiving their entitlements. |
Key Takeaways
If you are involved in a business partnership, consider implementing a profit share agreement. This agreement will detail how you and your partners divide profits. Without this document, issues can arise down the line, like who is owed what percentage of the business profits. Therefore, it is easier to ensure everyone is on the same page from the beginning.
For more information on how a profit share agreement can benefit your partnership, contact LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
Frequently Asked Questions
This agreement is a contract between the partners that outlines how profits will be shared.
If your business operates through a partnership or joint venture structure, you should have a profit share agreement in place. However, if you operate your business through a different structure, other documents may already cover the details of profit division.
This agreement will ensure everyone is on the same page from the beginning about the share of profits amongst partners, meaning disputes are less likely. If a dispute occurs, the agreement will outline a process to attempt an amicable outcome.
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