Profit Sharing Agreement
If one is 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, the business might be more complex, or you and one’s partner wish to delve into greater detail about the profit-sharing arrangements. In that case, one can consider drafting a partnership profit sharing agreement. A partnership profit sharing agreement is also useful when two unrelated parties collaborate on a specific project. This is as opposed to conducting an ongoing business together, known as a joint venture.
Definition of a partnership profit sharing agreement
A partnership profit sharing 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.
Before entering a partnership, one should create written contracts that cover all the agreements. A profit-sharing agreement generally expresses the ratio you’ll use to distribute profits as well as how you’ll divide any losses. Ratios may be determined by the amount of investment each partner put into the business or one may have an agreement that only divides profits, leaving one to take the hit for losses. A partnership doesn’t exist, however, if profits are not shared.
Ratios for division of profits and losses
One can divide the profits and losses in any way you want. The important issue is that all the partners agree on the ratios and sign a contract stating so. The only important detail to keep in mind is that when added together, all the portions equal 100 percent. For example, if you have three partners, you each can’t take one-half of the profits. Split evenly, you’d each take 33.3 percent. Perhaps you invested the most and plan to run the company; you might split profits so you get 50 percent and each partner takes 25 percent.
Rules for running the business
The partnership profit sharing agreement should spell out sweat-equity payments if you are going to run the business. For example, one might agree to a base salary and compute profits after that is paid. Other rules of the profit-sharing agreement should be written out and could include a section that precludes any single partner from making loans out of the profits or making other expenditures without full agreement of all the partners. Terms that spell out the dissolution of the partnership also should be included in the profit-sharing agreement.
Elements of a partnership profit sharing agreement
- Profit-sharing
Perhaps the most important term (at least from the parties’ perspectives), the partnership profit sharing agreement will need to contain provisions that outline how partners will share profits. Key considerations include:
- what the split is
- how partners will calculate profit
- when profits will be distributed.
- Dispute Resolution
During the life of the business, partners may disagree about the profit-sharing arrangement. Therefore, it is essential to include a disputes resolution process in the partnership profit sharing agreement. Hence, partners will have a clear process to follow, making it more likely to resolve any differences amicably. It is also essential to include information about what to do should this process fail.
- Termination
The partnership profit sharing agreement will usually contain a clause that outlines how each party can terminate the 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 profit sharing agreement as a whole? These are issues one should discuss with their partners and include in the agreement.
- Obligations
One 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 the partnership profit sharing agreement is based on the performance rather than a fixed percentage. Ultimately, each party should promise to deliver their services with skill and care.
- Confidentiality
Additionally, the partners may wish to keep the terms of the partnership profit sharing 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.
Other aspects of a partnership profit sharing agreement
- Reference of the parties involved
A partnership profit sharing agreement should reference all parties involved by name and address at the top of the contract. You should write the name of the business you’re forming in the beginning of the agreement as well as the purpose of the business. Include references as to the date the agreement is established as well as how long it’s expected to last. References should be made as to what accounts profits will be deposited into and when payment of those profits will take place.
- Restriction on partners’ actions
A partnership profit sharing agreement usually includes restrictions as to what each partner can do with company resources. It also spells out the steps you need to take in the event one of the partners dies. For example, you may write in the agreement that the remaining partners have the first option of buying out the remaining portion of the business from the estate of the deceased partner. One can place restrictions on the estate in the partnership profit sharing agreement that limit the estate’s involvement in the business.
Alternatively, you may include restrictions on how the remaining partner liquidates the business and distributes the profits. The main objective of the agreement is to cover every possible scenario in your original contract to avoid disputes and to continue operating smoothly in any event.
- Mission
The purpose of the partnership profit sharing agreement is a vital portion of the document. Partners must agree on the company mission and purpose, which markets you plan to target and what kind of financial goals you want to achieve. One can leave the mission portion of your agreement loose so you have room to expand it as your business grows, or you can keep it concrete and specific. The primary purpose of including a purpose statement in your agreement is to keep your work on track.
- Resolutions
Partners may disagree, but one should agree upfront how all partners will resolve those conflicts when they arise. Decide whether you’ll use mediation when disputes arise and which outsider you’ll employ. Each state has laws that govern partnerships if you don’t cover all legal bases in your initial partnership agreement or you don’t have an official document. However, it’s in your best interests to include information about resolving differences, so you can continue doing business when they arise and avoid legal consequences, such as court time and attorney fees.
- Authority
Decide in advance who plays what roles. For example, one of the partners may be in charge of sales and hiring, while the other partner handles invoicing and office management. The partnership profit sharing agreement should detail how decisions are made in the company, under what circumstances a single partner can make decisions and in what cases both parties must agree to an action. Include guidelines for bringing in additional partners. Divide the workload and write down how many hours partners agree to work each week, how much time you’ll each take off and who makes decisions when one party is unavailable. Try to cover every situation you can think of when writing decision-making guidelines.
Importance of a partnership profit sharing agreement
Before one begins drafting a partnership profit sharing agreement, it is crucial to ensure that the business will benefit from this document. There are several different business structures, and not all of them require partnership profit sharing agreements. That is not to say that partnership profit sharing agreements are undocumented in non-business partnership structures.
Further, a partnership profit sharing 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. Moreover, if one’s operates through a partnership or joint venture structure, one should have a partnership profit sharing agreement in place. However, if one operates a business through a different structure, other documents may already cover the details of profit division.
Also, if one is involved in a business partnership, one should consider implementing a partnership profit sharing agreement. This agreement will detail how 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.
Reasons for implementing a partnership profit sharing agreement
- 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.
- Each partner’s profits will form part of their personal income tax. Hence, having this agreement in place means they can plan accordingly. Such includes by setting up a trust to account for extra income.
References
http://www.business-in-a-box.com/profit
https://www.zapmeta.ws/web/results
https://search.visymo.com/search_now
https://www.assets.publishing.service.gove.uk
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