WA Profit Sharing Agreement or Collaboration Agreement?

[cyphix]

Basically the situation is a contact of mine approached me with an idea he had and told me all about it. It basically got down to us talking about doing it 50/50 profit wise. He is based in California ("Party A") and I am based in Australia ("Party B"), but the contract / agreement may be setup to run under WA / Australian law or is it better to be setup under the state law where he resides since that is where the business will be registered?

Now, he's a web designer and I'm a web developer, so we both have our roles sorted out - plus he will handle most of the business side of things and a lot of the marketing and at least initially most if not all the costs.

Since we have been discussing it, I have contributed a number of good ideas to the project, one of which is rather critical and from what I have seen is rather unique to what is currently on offer at the moment with our competitors - on top of that I also came up with the website / business name.

So on the business side of things we have been talking of how it will work. We discussed a partnership idea but because of various reasons decided it's too messy / too much paperwork, etc. with us based in different countries plus, he said he would prefer to keep controlling interest in it since the original idea was his - so like if he wanted to sell the company for example I couldn't stop him.

So then we started talking about profit sharing and how that would all work; I started searching around the web and found out you can get sample contracts for a "Profit Sharing Agreement" or something else that may suit our case with that being a "Collaboration Agreement" - so I'm not sure really how much these differ and what would suit us best.

Some points of note:

• The business will be registered to Party A only

So basically some points we want to cover:

• Party B will receive 50% of ALL profits related to the business, but will not be responsible for any losses
• Party B should also receive 50% of the sale price if the company is ever sold
• Party A should have controlling interest in the company to have the final word on all decisions
• If Party B fails to build the website within a specified amount of time, Party A can forfeit this agreement and find someone else to do the job - however, if this happens Party A will still need to pay Party B 10% of all profits for the website (+ 10% of any sale of the website) unless Party A removes features from the website that were the idea of Party B
• All costs related to the website will be covered by Party A unless otherwise agreed
• Financial documents (account statements, tax return etc) will be shared with Party B on request
• Not sure the best way to handle this, would need some thought, but something to cover case where of either party didn't want to (or were unable to) maintain or update the website anymore - like they shouldn't just stop getting their 50%
• Something to state when Party B will be paid their profits - like a schedule
• Profits may be chosen to be reinvested back into the business by either party; said amount will need to be an equal agreed upon amount from both parties.

Think I have covered everything unless anyone can think of anything else? But those are the main points.

So anyway, basically wondering which of the two agreements would suit us better under contract law?

Thanks a lot!

 

[Victoria S]

Hi @cyphix

• The best way to get this right is to get a lawyer to draft and/or review your agreement, before you sign it.
• Generally, whether the agreement is called a profit share or a collaboration doesn't matter. What matters is that the terms of your agreement reflect what you actually agree to - I see you've set out the gist above.
• Also make sure the termination clause reflects what you want to happen/the process if the relationship goes sour, as well as a liability clause that protects you.
• Have a look at the WA Small Business Development Corporation "Legal Matters" page.

 

[cyphix]

Hi @cyphix

• The best way to get this right is to get a lawyer to draft and/or review your agreement, before you sign it.
• Generally, whether the agreement is called a profit share or a collaboration doesn't matter. What matters is that the terms of your agreement reflect what you actually agree to - I see you've set out the gist above.
• Also make sure the termination clause reflects what you want to happen/the process if the relationship goes sour, as well as a liability clause that protects you.
• Have a look at the WA Small Business Development Corporation "Legal Matters" page.

Hi Victoria - thanks for your message.

I think anyone would love to get a lawyer to handle this type of stuff right off the bat, but they are just so expensive. That's why I was hoping an existing template agreement + some tweaks would be able to handle it.

 

[Sarah J]

Hi Cyphix,

1. Whether you (1) should set up a "profit sharing arrangement" or a "collaboration" (i.e. joint venture) and whether you (2) have set up one correctly will depend on in which jurisdiction you wish the venture to be governed. It does not matter what you call the venture, if it has the characteristics of type one, it will be considered type one under the governing law. Therefore, it is best to speak with a commercial lawyer who understands Australian and American law in order to decide which jurisdiction is better suited for this venture, and then, what the characteristics of one is verses the other. If it really is planned to be set up as you described above, meaning that person A will have control and the casting vote, then it will likely be that the governing law will also be from person A's jurisdiction.

2. It appears that you are trying to set up a sole proprietorship (i.e. no legal entity) under which you are entitled to 50% of the profits under contract law (i.e. equitable interest). Is this correct? The profit sharing and how it is done does not matter so much as under whom is the business registered (with the relevant authorities in the relevant jurisdiction). Therefore, the key question is whether it has its own legal entity (i.e. incorporated) or no separate legal entity (i.e. person A is personally liable for business debts, liabilities and costs).

 

[cyphix]

Thanks a lot Sarah.

It appears that you are trying to set up a sole proprietorship (i.e. no legal entity) under which you are entitled to 50% of the profits under contract law (i.e. equitable interest). Is this correct?

Almost. Party A is planning on registering the business as a LLC because of the protection a LLC provides. On that note, I assume since I'm not technically an owner/partner of the business I couldn't be held liable either if the company gets sued?

 

[Sarah J]

Hi Cyphix,

An LLC is a good idea. Essentially, an LLC is a "partnership" with two or more "partners" (i.e. it does not have a separate legal entity and all the hassles that come with companies and regulations). Each partner is limited by the amount of investment they put into the LLC. So, if you put in $10,000 as an investment into the partnership pool then you will only be liable for the amount, up to $10,000, that you have not yet paid up. If you have paid the full $10,000 into the partnership, then where the LLC is liable, part of that $10,000 will flow through to cover costs and expenses. Neither you, nor Party A, should be personally liable beyond the amount of investment you put into the partnership.

Australia does not recognise an LLC (as yet as far as I know). America does as this is an arrangement permitted with their tax agency and created under statute. The closest thing in Australia to an LLC is a trust (flow through taxation but no limited liability) or Pty Ltd (limited liability but a company).

 

[cyphix]

Ok thanks again for the info.

Do you know if I would need to b a part of the LLC or could he create the LLC himself and I would just stay a non-partner but still earn 50% via the proposed profit sharing agreement?

 

[Sarah J]

That would depend on the laws of the registering state (e.g. Delaware, US). Some states require at least two partners to register a LLC.

 

[cyphix]

That would depend on the laws of the registering state (e.g. Delaware, US). Some states require at least two partners to register a LLC.

Ok thanks very much!

 

[DennisD]

Hi cyphix

Sarah J seems to be pretty across this area, especially for an Oz lawyer. The only point which I would reiterate is that substance matters over form, ie what the agreement says rather than what it's called

Also, yes we all hear you when you say lawyers can be expensive, but I would say not necessarily crazy money, and it's about value to your business. Practical business people can resolve most matters without engaging a lawyer, but getting that critical agreement in proper shape can save so much time, effort and money in the long run, plus if you go to a smaller firm you might be surprised by an ok, fixed costs quote. People sometimes think because they have a commercial terms sheet they have a deal, but as the saying goes the devil's in the detail, and to have legal certainty as different situations unfold will free up a lot of energy for your commercial activities. Anyway you might decide to draft the agreement yourselves depending on costs, however I would seriously suggest considering the value lawyers would add to you here, ideally as Sarah J suggests 'a commercial lawyer who understands Australian and American law'