When entrepreneurs need funding, the choices often feel binary: take on debt through a loan, or give up equity to an investor. But there’s another option — one that blends flexibility with clear boundaries: the Profit Participation Agreement (PPA).

At its core, a PPA allows investors to share in profits (and sometimes losses) of a project or business, without taking ownership of the company itself. This structure is increasingly popular in real estate, joint ventures, and certain startup deals, but it’s not without risks. Let’s break down when to use PPAs, how they work, and what pitfalls to avoid.

What Is a Profit Participation Agreement?

A Profit Participation Agreement is a contractual arrangement in which one party (the investor or participant) contributes capital to a business or project, and in return receives a defined share of the profits generated. Unlike equity investments, the investor doesn’t hold shares or membership interest in the entity. Unlike loans, there isn’t always a fixed repayment schedule or guaranteed return.

Think of it as a hybrid between a loan and an equity deal:

The investor gets upside potential tied to actual performance.
The business owner retains control and avoids ownership dilution.

When to Use a PPA

PPAs are most useful in situations where:

Traditional financing isn’t available
– Banks may shy away from speculative or early-stage ventures.
Equity dilution is undesirable
– Founders or property owners want to keep control.
Cash flow is uncertain or project-based
– Real estate developments, film production, and certain startups where future profits are the true “collateral.”
Investor appetite is performance-driven
– Investors want skin in the game and returns that rise with success.

Benefits of Profit Participation Agreements

For Business Owners:

No ownership dilution – You maintain full control.
Flexible terms – Profit-sharing can be tailored to milestones, timeframes, or tiers of profitability.
Aligns interests – Investors only benefit when the business succeeds.

For Investors:

Upside potential – Returns may be higher than fixed loan interest.
Targeted exposure – Ability to participate in specific projects without committing to full equity ownership.
Simplicity – In some cases, faster to negotiate than complex equity structures.

Key Risks & Pitfalls

PPAs can be powerful tools, but they come with traps if not carefully structured:

Ambiguity in Profit Calculation
– The biggest source of disputes is how “profit” is defined. Does it mean net profit, gross profit, or distributable cash? Accounting methods can dramatically shift the numbers.
Regulatory Issues
– Depending on structure, a PPA may be treated as a security under state and federal law. That triggers disclosure obligations and compliance requirements.
Investor Expectations
– Unlike a loan, there’s no guaranteed return or timeline. Unsophisticated investors may misunderstand the risk, leading to conflicts.
Cash Flow Strain
– Businesses must share profits even when reinvestment might be wiser. If structured poorly, PPAs can drain growth capital.
Tax Implications
– Profit-sharing can trigger unexpected tax treatment for both parties if not carefully planned.

How PPAs Differ From Loans and Equity

The best investment in a company requires the knowledge and skill of trained attorneys to advise on the structure of the investment prior to engaging. Whether you’re the business owner or the investor, contact us to help you make sure that you’re setting yourself up for success and reducing liability and risk.

Profit Participation Agreement: A Flexible Tool for Business & Real Estate Deal