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What is a Profit Sharing Contract?
A profit sharing contract is a legal agreement that two entities use when they work together on a project-based time period. This differs from a general partnership, as the two entities do not form a new company.
This type of unincorporated joint venture applies when two entities, such as two small businesses or corporations, act as a business partnership to reach a shared goal.
Similar to a joint venture agreement or a joint venture contract, a profit-sharing agreement relates to the responsibilities and division of profits for a specific period of time. Generally, this concerns a particular project that the entities work on together.
In this sense, a profit sharing contract can be seen as a collaboration agreement.
Here is an article with more information on profit sharing plans.
What’s Included in a Profit Sharing Contract?
A profit sharing contract covers all the details relating to a collaborative partnership. Details and contents of each contract will vary, which is why many businesses choose to work with a business attorney to draft their profit-sharing agreement.
At the most basic level, all profit sharing contracts must include:
- An introduction of businesses : The legal names of the entities and operating parties should all be introduced at the contract's start.
- The purpose of the contract : The contract should set an agreement to share profits generated from a specific campaign or project with a specific start and end date.
- Description and scope of the project: You can use the profit sharing agreement to describe the type and scope of the project you are undertaking with your partner(s).
- Timeframe : Set a time period for the profit-sharing arrangements to stay in effect. This will be the period of time that makes up the length of the final contract.
- Confidentiality clause : This provision ensures that the details of the project collaboration agreement and project venture stay between the parties.
- Non-compete clause : Either or both parties may want a non-competition agreement to prevent their partner from entering into another venture with a competitor.
- Responsibilities: Each party will have responsibilities to uphold as a part of the partnership. This agreement can outline both shared and individual responsibilities of each party.
- Disclaimers : Both parties may wish to clarify that this collaborative project represents a partnership, but it does not form a new company or entitle the other party to profits a company earns beyond this project's scope.
- Dispute resolution : Lay out what steps the parties agree to take to resolve potential disputes.
- Termination rights : What rights do the parties reserve to terminate their agreement, and under what circumstances? Furthermore, what consequences will there be if a party breaches part or all of the agreement? Again, the terms should be clearly defined.
- Division of profits : The contract should describe how profits will be distributed among parties. The final dollar amount may not be known when drawing the contract. In that case, a percentage of total profits earned between the agreement’s time period should be included.
Here is an article you can reference to review the elements typical of this type of agreement. However, suppose you do use this document. In that case, we suggest consulting with an attorney to review the details before signing to ensure you have a full understanding.
When Should You Use a Profit Sharing Contract?
Using a profit sharing contract is best when you collaborate on a joint project with another company or individual.
Most importantly, you should use a profit sharing contract to ensure that everyone involved is paid fairly.
Profit-sharing entitles each person to a fair percentage of the money their efforts produce. For example, suppose you will work with a company on a shared project. In that case, this contract can establish rules, guidelines, and payment terms easily.
This will negate the possibility of miscommunication in terms of payment and also define what is expected from everyone involved.
Profit sharing contracts can accompany other typical documents in business ventures, such as non-compete agreements, collaboration agreements, and nondisclosure agreements.
Here is an article with tips for drafting a profit sharing contract.
Image via Pexels by Andrea Piacquadio
How Do You Structure a Profit Sharing Contract?
You can structure a profit sharing contract by using a profit sharing agreement template. You can also work with a lawyer well-versed in joint ventures and business. They can draft a profit sharing contract for you that reflects the unique needs of your partnership.
If you use a contract template, make sure that you include the following:
- The full names of all parties
- A description of the project
- Important time frames
- Profit-sharing rules
- Payment methods
- Limitations of liability
If there are any terms you are unsure of, a lawyer is the best resource. They can assure that all of the necessary legal terms are in place to prevent future lawsuits or a void contract.
All parties must negotiate the terms of the agreement before signing. Therefore, consideration is a major factor that influences revenue sharing.
In law, consideration is something that parties bargain for and receive. In the case of profit sharing agreements, this could be the amount of capital in exchange for a percentage of the total gross revenue a project generates.
What matters most is that you and all partners are in unanimous agreement about the terms and conditions of your partnership.
Here is an article where you can learn more about what makes a contract legal.
Benefits of Profit Sharing
Profit sharing allows companies to earn more money by collaborating and sharing their resources.
You can also gain access to new markets more easily by leveraging your partners’ existing audiences. Even when part of a time-limited agreement, businesses can gain serious advantages through access to another company’s resources.
Profit sharing also allows companies to enter formal collaborations with less risk. Because they are not forming a new company, each partner can still operate independently and faces less liability.
For small businesses, collaborating with larger partners can result in substantial growth. So even if you agree to a smaller percentage of profits, the results of your partnership can create long-standing benefits.
Here is an article that looks closely at business collaboration and its benefits.
What is a Typical Profit Share Percentage?
Profit sharing percentages can vary greatly by company and even by project. In addition, individual shareholders may earn more depending on their share amount, voting rights, and contribution level.
The average profit share percentage is between 2% and 10%. Each company will determine the fairest amount for stakeholders.
Here are some additional factors that influence profit share percentages:
- Level of responsibility: If one shareholder has greater responsibility in the project, they will likely be given a greater share of any profits their efforts generate.
- Capital investment : The amount of capital a partner invests throughout the project’s lifecycle will influence the percentage of profits they are entitled to receive.
- Agreed-upon ratio : Partners may work together to determine a fixed profit-sharing ratio they agree to receive throughout their collaboration agreement.
Here is an article about how revenue sharing works and the average amount most partners receive.
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