Sharing profits or revenue between business partners is a key element of a successful business. A Profit or Revenue Sharing Agreement outlines how to share profits or revenue between business partners and in some cases, how to divide any losses.
Profit or Revenue Sharing
Sharing profits or revenue between business partners is a key element of a successful business. A Profit or Revenue Sharing Agreement outlines how to share profits or revenue between business partners and in some cases, how you will divide any losses. Although neither of these agreements are legal requirements, they are an incredibly useful tool for your business and can be used from start to finish.
So firstly, what exactly is a Profit Share Agreement?
A Profit Share Agreement is a legal document or contract which allows for profits between business partners, along with the potential losses, to be shared between themselves.
Here is an example:
Assume you and your business partners plan to purchase an item for R50 and sell it for R100. In this scenario, R100 is the revenue and the profit would be sale price – cost price (R100 – R50), which would total R50.
If you have three partners along with you, you can’t each receive 100% of the profits. Split evenly, each business partner would receive 25% of the R50 profit. However, it is not always as simple as this.
Perhaps you created the company or invested significantly, and may now want to split profits so that you receive 50% (R25) and your other partners receive the remaining share (R8.33 each). This type of agreement is achieved using a profit share agreement.
What then, is a Revenue Share Agreement?
Similarly, a Revenue Share Agreement is a legal document or contract which allows for revenue between business partners to be shared between themselves, along with potential losses.
The main difference between a Profit Share Agreement and a Revenue Share Agreement is that a Profit Share Agreement allows for your business expenses to be deducted from revenue prior to the profit being split between business partners.
A Revenue Share Agreement, on the other hand, does not allow for this deduction.
Here is an example of a Revenue Share Agreement in practice:
Again, you and your business partners plan to purchase an item for R50 and sell it for R100. In this scenario, R100 is the revenue.
If you and your three partners agree to an equal share of the revenue, then you will all receive 25% (R25). Similar to the Profit Share Agreement, the total revenue may be shared unequally as agreed upon by all business partners.
Understandably, you may not be aware of all the differences between a Profit Share Agreement and a Revenue Share Agreement. To better explain the key differences and similarities between the two agreements, have a look at the figure below:
The Main Benefits of Profit and Revenue Share Agreements
- Provides financial security for both parties. By legally agreeing to Profit or Revenue sharing terms and conditions, you may all proceed with your business venture with peace of mind
- Prevents future misunderstandings and disputes. By making sure all partners are on the same page and understand their respective responsibilities, you negate future disputes or potential conflicts
- Specifies how partners may or terminate the agreement, and what constitutes a breach. Should issues arise, both parties will have a copy of the contract to refer to and be aware of the grounds on which the agreement can be ceased
- Establishing a Time Frame. The point at which partners begin sharing Profits or Revenue can disproportionately and significantly affect specific partners or parties. Negotiating a fair commencement date is key, as is the duration of the agreement. Specifying the full timeline, in detail, benefits all partners.
Quite simply, if you are entering into a business agreement, you are most likely going to have to negotiate how you and your partners split your business’ earnings. If this is the case, either a Profit or Revenue Share Agreement is indispensable.
The 50-50 partnership or 50-50 profit share Agreement
Typically most joint ventures will start with a 50-50 partnership. This is a type of business partnership where each partner holds an equal share of the partnership's assets, liabilities, and profits. This means that both partners have equal decision-making power, equal access to the partnership's resources, and are equally responsible for the partnership's debts and obligations. This type of partnership is often used when starting a new business or when two existing businesses decide to merge. A 50-50 partnership can provide a balance of power, as well as a sense of shared ownership and responsibility. However, it is important to have a clear partnership agreement in place to define the terms and conditions of the partnership, including decision-making processes, dispute resolution procedures, and financial and management responsibilities. This will help to ensure that the partnership runs smoothly and that both partners are on the same page.
Key advantages of a 50-50 partnership
A 50-50 partnership can provide a number of advantages, including:
Shared ownership and responsibility: Both partners have an equal stake in the business, which can foster a sense of shared ownership and responsibility. This can lead to a more committed partnership and greater investment in the success of the business.
Balance of power: With both partners having equal decision-making power, there is a balance of power that can prevent one partner from having too much control over the business.
Shared expertise and experience: With both partners bringing their own skills and experiences to the table, the partnership can benefit from a broader range of expertise and experience.
Shared financial risk: With both partners sharing the financial risks of the business, the burden of financial loss is spread out, reducing the risk for any one partner.
Increased capital: A 50-50 partnership can bring together two sets of assets, which can increase the capital available to the business.
Better decision-making: Two heads are often better than one and having two partners with different perspectives can lead to better decision-making and problem-solving.
Increased accountability: With both partners having an equal share of the business, they are both accountable for its success, which can lead to increased productivity and a stronger sense of commitment.
Better Business Continuity: When both partners are present, the business can continue to operate in case one partner is unavailable, this can be important for long-term sustainability of the business.
It's important to note that a 50-50 partnership is not the best fit for all businesses or all partners, it's crucial to have a clear partnership agreement in place and evaluate if it will work for the specific business and partners
Disadvantages to a 50-50 partnership
There are several risks associated with a 50-50 partnership that should be considered before entering into such an arrangement. Some of these include:
Decision-making paralysis: With both partners having equal decision-making power, it can be difficult to reach agreements on important matters. This can lead to delays in making decisions, which can negatively impact the business.
Deadlock: If both partners are unable to reach an agreement, the partnership may become deadlocked, which can result in the inability to make important business decisions.
Equal liability: Both partners are equally liable for the partnership's debts and obligations, which can be a significant risk if the business is not successful.
Lack of incentives: With both partners having equal ownership, there may be a lack of incentive for one partner to work harder or take on more risk than the other.
Personal conflicts: A 50-50 partnership can be affected by personal conflicts between partners, which can be difficult to resolve and can negatively impact the business.
Conflicting visions: Partners may have different visions for the business, which can lead to disagreements and tension, which can be detrimental to the partnership.
Legal disputes: Without a clear partnership agreement, legal disputes can arise, which can be time-consuming and costly to resolve.
It's important to be aware of these risks before entering into a 50-50 partnership and to have a clear partnership agreement in place that addresses these issues and defines the terms and conditions of the partnership. Additionally, choosing the right partner with complementary skills and values can reduce some of the risks and make the partnership more successful.
It is of utmost imporant to discuss these advantages and disadvantages with both principal shareholders before comiting to a joint venture agreement. Everyone needs to understand what they are in for, to avoid costly legal actions when things go wrong. The purpose of this agreement is to detail what happens when things go wrong, keep that in mind.
Key Elements You Need to Understand about Profit and Revenue Share Agreements
Understanding contracts is an undeniably daunting task, so we’ve explained a few terms to help you simplify the process.
**#1: Commencement **
There are a number of important dates in a contract – one of them being the Commencement date or clause. This date specifies when the contract will begin or commence and may also be initiated by a defined event. It is important that all partners are aware of and agree upon this date.
Partner A is selling hats and Partner B is developing an online webstore. The partner who is selling hats has developed the product, invested in building a brand and has covered all the costs thus far. Partner A (the hat seller) wants to negotiate a greater share of the profit or revenue and only wants to begin the sharing process once he/she is certain that the webstore and business endeavour will be rewarding.
In this scenario:
The Profit or Revenue Share Agreement will commence on a date agreed upon by both partners, or
The commencement date may be negotiated to begin only when the webstore is determined to be fully operational.
Failure to include a defined commencement date may result in your business losing out on profits or worse, also enduring unwarranted losses.
#2: Duration & Termination
Duration outlines the term of a contract and therefore, how long a contract is valid – in this case, the Profit or Revenue Share Agreement. Simply put, it is the amount of time that the agreement will remain in effect or continue to apply. Once again, this may be a predefined length of time or underpinned by a defined event.
Termination of an agreement or contract refers to the legal process of ending contractual duties before they have been fulfilled or once they have been fulfilled. There are numerous reasons for why partners may choose to terminate or end an agreement.
However, not all terminations of agreements may be mutual so it is important to note that partners intending to terminate may not be able to escape liability or continuing to have to part with profits or revenue.
Partner A intends to advertise their products on a popular billboard and has entered into a partnership with Partner B, who owns a billboard advertising company. The Profit or Revenue Share Agreement is due to commence from the date agreed upon by both parties and will be valid for the duration that the product is advertised on the billboard which is, in this case, an agreed upon period of two years.
In this scenario:
- The Profit or Revenue Share Agreement will be valid for two years, or
- The Profit or Revenue Share Agreement will only be valid whilst the billboard exists, or
- Both partners can agree to terminate the agreement
It is very important that all partners agree upon and are aware of the duration of the agreement. Failure to include clear terms, may result in the agreement being valid indefinitely, terminated prematurely or may lead to potential misunderstandings.
#3: Profit Share and Deductions
“Profit Share” clauses in a Profit or Revenue Share Agreement form the meat of such an agreement. It is probably the first clause that you, a business partner entering into an agreement, would want to read. It details how the profits will ultimately be divided between partners or parties.
This clause provides clarity on how exactly partners will divide the profit.
The Profit Share will also detail the expenses that will be deducted from revenue to arrive at the profit, which will then be split between the partners. This was illustrated in detail in Example 1
This clause records all expenses and deductions which need to be deducted from the revenue to arrive at the profit to be split. This is an important detail, as you do not want to have ambiguous recordings of expenses which might cause a dispute at a later stage.
In the unfortunate case that a partner or party is found to be in breach of an agreement, it is important that you have taken the necessary measures to prepare beforehand.
This includes all partners drawing up and agreeing upon potential remedies that should be made available to those who were not in the wrong.
This clause will usually provide that a partner or party has a right to claim specific performance or even cancel the agreement in some instances where another partner is found to be in breach.
In the case of the person selling the hats partnering with the owner of the webstore in the previous example. If the web store owner refuses to sell the hats or fails to declare correct profits/revenue as initially agreed upon in the contract, he/she will be in breach of the contract.
#5: Force Majeure Event
This is somewhat of a technical legal term.
It simply means an incident or event beyond the reasonable control of all partners or parties which has a significant impact on the ability of one or both of the parties to be able to perform in terms of the agreement.
The force majeure clause will normally state that the interrupted party may be relieved of their duties and obligations for the duration of the force majeure event and its consequences, provided that the interrupted party notifies the other of the event.
In the event that a force majeure event continues for a prolonged period of time, this clause would normally specify how long the force majeure event may continue for before the parties would be permitted to either negotiate a reconstruction or terminate the agreement.
An example of a force majeure event may be a pandemic such as COVID-19 which may make it impossible for you to meet the commitments of the agreement you previously negotiated with your partners.
#6: Boilerplate clauses
Apart from the above, all Profit and Revenue Share Agreements should contain standard boilerplate clauses (also commonly referred to as standard or general clauses). These clauses are included in the agreement to ensure certainty and prevent ambiguity.
These clauses would include, for example:
Domicilium and Notices
Governing Law and Jurisdiction
Dispute Resolution Procedures
Non-Variation of Agreement Provisions
Whole Agreement Provisions
Boilerplate clauses, although commonly included at the end of agreements, are just as essential as the other clauses. They are often varied and may be confusing which is why we have written another full blog dedicated to explaining just these, here.
Over to You
We know that drawing up any legal contract or entering into a business agreement is daunting. What we also know is that proper contracts are the essential building blocks of your business.
But, the task of producing a Profit or Revenue Agreement (or any business contract for that matter) should not deter you from taking the necessary steps in your business’ journey.
In the past, you had two options. The first included exorbitant legal fees and the second involved you drawing up your own agreements (and possibly excluding key clauses).
Hello Contract is changing all of that for the ordinary South African business.
At Hello Contract we believe in an entrepreneurial future. By generating professionally automated and affordable contracts, we strive to provide people with the tools necessary to build their company, and take control in building their own future.