By Cliff Ennico
“My husband and I have a small consulting business.
We want to hire someone as a subcontractor for some of our projects, but are nervous about paying her a flat fee per hour or per day as we cannot be sure our clients will agree to pay that way.
I worked up what I thought was a very simple plan. On projects where this contractor would be helping us, we would submit our usual invoice to the client. Then when the payment comes in, we would deduct all expenses relating to that invoice (including a portion of our company’s overhead and administrative costs which will be spread over all invoices), and whatever was left over we would split 60/40 with the contractor.
The contractor said she was willing to work with us that way, but when I discussed this with my attorney he freaked out and said he couldn’t draft an agreement reflecting this arrangement. Do I have the wrong attorney, or is there something more to this than I think there is?”
You may well have the wrong attorney (I can’t speak to that), but there is definitely something more to this than you think. While an arrangement like this one is very simple to state verbally, as you just did in your e-mail message, it is almost impossible to put it into legal language that will be enforceable in a court of law.
Generally, “agreements to agree” are not enforceable, and what you propose to do is technically an “agreement to agree.” If you and your subcontractor get into a dispute down the road there is no way a judge, jury or other third party looking at this contract can determine exactly how much your contractor is supposed to be paid on any given project.
Specifically, your proposed fee-sharing arrangement leaves open the following matters:
Does the subcontractor’s proposed 40 percent split give her a fair return on her investment of time in each project?
- When will each invoice be payable, and how long after you receive your money will be subcontractor be paid her 40 percent split?
- Will your subcontractor’s input be included in each invoice, and if so how will that input be valued?
- What “project specific” expenses will be deducted from the face amount of each invoice?
- Will expenses incurred by your subcontractor be included in each invoice, and if so will she receive reimbursement of those expenses before you calculate the 60/40 split?
- What “overhead and administrative” expenses will be deducted from each invoice before you calculate the 60/40 split?
- Will “overhead and administrative” expenses include any compensation to you and your husband as the owners of the business?
- Will the same percentage of “overhead and administrative” expenses be deducted from all of your invoices, or will you weight them based on the size of each invoice, the amount of business you receive from each client, or some other factor?
What you really want to do here is base your subcontractor’s compensation on the “net profit” from each project she works on. The problem with any arrangement like that is that you don’t know what the “net profit” of any project will be until expenses are deducted, and there’s lots of ways you can artificially increase your expenses to minimize or even eliminate “net profit” from any project. If I were representing your subcontractor, there’s no way I would tell her to agree to any such arrangement.
The only way to make your proposed arrangement legally clear is to say in the contract that you will make all deductions from the face amount of any invoice “in your sole discretion, after consultation with subcontractor.” That clears up the uncertainty, but if your subcontractor feels you are not making these decisions fairly her only option under the contract would be to quit, possibly leaving you in the lurch on an important client project.
The best and fairest way to handle this relationship is to give your subcontractor a percentage of the gross revenue your company “actually receives” from invoices on projects she has worked on. That is not only easier to calculate, but easier to draft in enforceable legal language. Requiring that the subcontractor be paid only when you receive payment from your client protects you against any “hard and fast” obligation to pay the subcontractor when your business is short on funds.
The arrangement you propose also raises the possibility that your client will view the subcontractor as your partner, exposing you to liability for her mistakes. You want your subcontractor to be treated as an “independent contractor” for tax and other purposes, and independent contractors generally receive fixed compensation, not a percentage of a business’ overall profits.
To eliminate any misunderstanding, your client contract should state clearly that the subcontractor is not a partner or employee and has no authority to make decisions for your consulting business.
Cliff Ennico (www.succeedinginyourbusiness.com), a leading expert on small business law and taxes, is the author of “Small Business Survival Guide,” “The eBay Seller’s Tax and Legal Answer Book” and 15 other books. @cliffennico