What Is a Profit Sharing Agreement?

A profit-sharing agreement is a legally binding contract that regulates and outlines the terms and conditions of a profit-sharing process. It is a document that two parties use in working together for a similar purpose, typically within a project-based timeframe. A profit-sharing agreement is also known as an incorporated joint venture agreement. In this scenario, two entities remain independent without forming a new and singular company or corporation for a single project. Each party offers a different set of skills and competencies to the business relationship. As such, the division of revenue reflects the division of responsibilities and possible risks between the two entities. Once the two parties have arranged the process of profit sharing, they must provide clear and comprehensive documentation of it. In providing the profit-sharing agreement, the entities will have a lesser occurrence of misunderstandings and confusion. A company can also use the document for employment purposes and dealing with independent contractors. The profit-sharing agreement applies to arrangements that deal with splitting revenue with an entity they work with for a specific period.

According to the Organization for Economic Cooperation and Development or OECD in their published article entitled Profit-sharing in practice in selected OECD countries, about three percent of firms with greater than a hundred employees engage in cashed based schemes of CPS, a subcategory of profit sharing.

Components of a Profit Sharing Agreement

There is no one format for writing a profit-sharing agreement. Since the document handles different industries and businesses, most profit-sharing agreements are tailor-made to fit the entities that engage in a profit-sharing arrangement. As a profit-sharing agreement can be for employment purposes or handling independent contractors, several elements may be present in one document that are not present in another. The person responsible for drafting the agreement must determine the necessary elements that must be in the document. This section of the article identifies the essential components of a profit-sharing agreement with helpful descriptions to provide a better understanding.

Profit sharing: One of the most vital elements of the profit-sharing agreement deals with the provisions surrounding the amount of profit that each party receives from the project in a ratio or percentage format. It must also consider and explain the process of calculating the division of profit, the set project timeline where the parties share the profit, and the expectancy date when a party can receive their profits. Termination: In the termination section of the profit-sharing agreement, there must be a list of clauses that outline the possible scenarios and circumstances wherein the parties have the grounds to discontinue or terminate the contract. It also indicates the terms and conditions when implementing the termination.Dispute resolution: If disputes arise between the parties while the agreement is in effect, indicating a dispute resolution clause is necessary to allow both parties to come together to discuss or resolve the matter before making any claims to the incident. Having this section in the profit-sharing agreement is advantageous to ensure that both parties are in good faith while working together. It also helps to mitigate the risks of lengthy disputes affecting the contract.Confidentiality: Every profit-sharing agreement must contain a confidentiality clause that states that both parties must keep the document and its terms and conditions confidential. This provision of the agreement remains in effect even after the termination of the contract.Obligations: The obligation section of the profit-sharing agreement outlines the roles and responsibilities of the involved parties in the contract. It consists of a comprehensive list that describes what one party supplies to the other as part of their project partnership. The parties also make certain promises to deliver or perform services with utmost care and craftsmanship. Identifying the responsibilities of each party saves time and confusion during the term of the contract.Intellectual property: Similar to many types of collaborations, it is inevitable for parties to share their intellectual property with the other or permit the other party to utilize it during the duration of the contract. The intellectual property clause also specifies or indicates who owns the intellectual property (IP) and what happens to a created IP during the collaboration project.Indemnities and liabilities: If some issues or scenarios arise under the implementation of the agreement, an indemnity clause and liability clause outline the incidents and extents of liability for each party. This section of the profit-sharing agreement also details whether or not one party seeks to indemnify the other. It also contains the predetermined amount of money that the parties agree to pay one another in case there is a breach of contract.

Types of Profit-Sharing Plans

Profit-sharing plans are mostly company-based plans between an employer and employee where employers provide a part of the company’s earned profit to its employees. Profit-sharing plans build a strong relationship between an organization and its employees, instilling a sense of ownership and responsibility in employees. There are different types of profit-sharing in a business and the section below talks about each one.

Cash plan: In a cash plan, the company’s cash rewards or existing stocks serve as a token of appreciation to employees. This type of profit-sharing plan awards employees in different payment schedules, either quarterly or annually. Through this extra income in the employee’s paycheck, they are also under the obligation to pay taxes. It is one of the disadvantages of having this type of profit-sharing arrangement with employees.Deferred plan: A deferred plan is another type of profit-sharing plan that an organization implements. In a deferred plan, employees do not see an immediate payout from the profit-sharing arrangement with the company. Instead, a trust fund holds the earned rewards. A trust fund is an account that maintains the stocks and assets of an organization. Employees receive the rewards at the time of their retirement from the company.Combination plan: As the name suggests, a combination plan combines cash and deferred plan. In this type of profit-sharing plan, a part of the rewards from the company is in cash, while the other part is in a trust fund. Similar to a deferred plan, the amount in the trust fund transfers to the employee at the time of their retirement.Pro-rata plan: A pro-rata plan is a profit-sharing plan wherein employees receive similar amounts of money from employer contributions. It works similarly to an employer matching process wherein employees receive a specific percentage of their compensation package for a task, activity, or project as employer contributions. This type of profit-sharing plan is beneficial for employers who want to give additional benefits to their employees through a simple gesture.Age-weighted plan: When it comes to age-weight profit-sharing plans, an employer features the equivalent contributions corresponding to the age of retirement. Meaning an older employee gets a higher percentage contribution in comparison to a much younger employee. Applying this strategy is advantageous to retain talented employees. The longer an individual stays serving the company, they gain a much higher employer contribution rate in the long run.New comparability plan: The new comparability plan, also known as a cross-testing plan, is the most flexible for company owners. It gives employers the chance to make arrangements for them to personally receive the maximum possible contribution or for those who want to make contributions to their employees at different rates accordingly. In this type of profit-sharing plan, employers group employees according to different benefit groups where employers can receive a maximum percentage contribution while other employees receive a smaller amount. The new comparability plan is advantageous in organizations that have older owners and a younger workforce.

How To Implement a Profit Sharing Agreement

At the beginning of negotiations of a profit-sharing agreement, each party raises their concerns and expectations from the collaboration. There must be a clear vision and project goal of what the parties want to achieve at the end. Whichever profit-sharing plan the company chooses for their employees, the section below contains a helpful guide that will help implement the profit-sharing agreement for employees.

  • 1. Make Sure To Record All Essential Information in the Agreement

    The profit-sharing agreement must have all the necessary information from both parties. The document must indicate the details of the partners in the agreement, including personal accounts, identification cards, proof of mailing address, income tax statements, and asset list.

  • 2. Indicate the Investment Amount and Define Revenue Sharing Methods

    Each party is responsible for paying a specific amount of money at the beginning or an initial investment payment. The profit-sharing agreement details the specific amount that each party must contribute during the implementation of the project. It is also advisable to clarify the amount of money that each partner will receive. Revenue sharing can be in different types of profit-sharing plans. One of which is each party receives profit according to their contributions.

  • 3. Set the Terms and Conditions, Payments, and Distributions of the Agreement

    The terms and conditions of the profit-sharing agreement include information about invested ratios, vital information concerning the parties, and all other information that serves relevance in the document. Ensure that both parties understand and approve the terms and conditions of the agreement before finalizing it on the document. When it comes to profit shares, the distribution can either be immediate or at a later date. A company can distribute the profits to its employees in either lump-sum payments or business equities. Meanwhile, the transfer of profit shares is much later in deferred payment methods, the company storing the shares in a trust fund.

  • 4. Discuss Binding Effects, Waivers, Modifications, and Further Assurances

    The profit-sharing agreement between the parties is legally binding. The document becomes legally binding when both parties understand and agree on the terms surrounding the arrangement. Modifications to the agreement are possible according to the needs of the party. Either entity can make changes to the agreement so long as the other party has knowledge of the change and agrees. Assurance clauses can also be incorporated in the agreement, dealing with mortgages, but is not necessary.

  • 5. Define the Relationship and Execution Processes of the Parties

    In a profit-sharing agreement, there are no third parties that exist. If one of the parties brings in a third-party entity to participate in the agreement, the party responsible has a high possibility of losing the partnership or collaboration opportunity. Roles and responsibilities must be clear in the agreement since both parties have different perspectives on implementing the activity or project. The agreement must set explicit boundaries and limitations regarding various aspects of the business.

  • 6. Review the Entire Agreement and Details of Jurisdiction

    Finally, before both parties sign the profit-sharing agreement, there must be a comprehensive review of the document. Both parties are accountable for checking and making sure that both parties are in agreement before finalizing the document. It is also necessary to discuss the lawful jurisdiction surrounding the terms of the agreement.


What is profit and loss agreement?

A profit and loss transfer agreement is a document that details the transfer of a company’s entire profits to another company, intending to share both profits and losses at a certain rate or percentage.

How does a 50/50 partnership happen?

In a 50/50 partnership, the engaged parties each have a 50 percent share of a business. It means that neither can act without getting the other’s approval unless there is a clear distinction of responsibilities and that the party responsible for that aspect makes the decision.

How do partners share profits?

When it comes to profit sharing with other entities through collaborations, the parties can share profits by dividing the roles and responsibilities, setting capital contributions, and establishing a profit-sharing ratio.

Profit-sharing agreements exist internally and externally in an organization. External profit-sharing deals with collaborations and partnerships with a different company or organization for a particular project. Meanwhile, an internal profit-sharing agreement exists between an employer and employees. Make sure that the profit-sharing agreement covers the necessary provisions and terms catering to the relationship. Familiarize yourself with the document and draft your profit-sharing agreement by downloading the 4+ SAMPLE Profit Sharing Agreement in PDF from the article above. Get yours from Sample.net today!