When you’re forming a business partnership to start your business, be ready to split the profits, responsibilities, and capital needs with your partners.
Here’s some information you’ll need to understand partnership profit calculation, equitable partner splits, and how to develop and record, your profit-sharing strategy.
To start, let’s review exactly what profit is. The simplest explanation is that it’s sales minus expenses.
It becomes more complicated as you further define profit into gross profit (sales revenue minus the cost of goods or services sold) and net profit (all revenues minus expenses; the cost of goods, administrative, and overhead). Most partnerships split profits based on net profit and agree, in advance, specifically which expenses are included in that profit calculation.
The ZenBusiness Money app can keep track of all your expenses. It’s super easy to use. With a few simple clicks, you can track, categorize, and manage all your expenses and small business tax deductions.
First, to determine your split, you need to settle on the type of small business partnership for your firm. I highly recommend that you do not set up your partnership yourself. Instead, use a competent legal service or your local business attorney.
Percentage Ownership
Profit splits can match partners’ ownership shares, or not, as you deem acceptable – as long as all the partners are in agreement. Some companies split their profits equally, while many others pay each partner a salary and then divide up the remaining profits.
Begin by deciding the roles and ownership of each partner and their assigned salary and expense accounts. After that, you can discuss your profit splits. Be sure to include a detailed description of your profit-sharing arrangement in your partnership agreement document.
Responsibility Division
Partnership profit splits can be decided based upon each partner work, time and talent, invested into the firm. An example is when Individual #1 and Individual #2 form a partnership company, and Individual #1 runs firm and is responsible for its daily operations, thus they receive 70% of the profit while the less active Individual #2 gets 30%.
Capital Investment Contribution
Often partners invest different capital amounts to launch the company. As such the partner who contributes more cash is often entitled to a greater portion of the profits, but not always. As for everything about your partnership, it is up to the people involved and their preferences. Thus if one partner invests 80% of the total launch funds they could receive 80% of the profits or less. Differing profit distributions to capital investment could be due to the other partner’s investment of work, time and talent.
Written Partnership Agreement
The key to a good working partnership is a clearly written, and well-discussed, agreement on these vital points. Not legally required in all states or industries, this document will protect the partners’ interests and assist in daily business operations.
Business Structure Differences – DBA, LLC or INC
Take into consideration what your partnership and company business structure, whether DBA, LLC or INC, dictates about profit splits. Corporations generally issue stock shares and pay dividends as a form of profit splits, while LLC distribute profits, in direct relation to cash investment, in accordance with the operating agreement drafted at inception.
Business Partnership Taxes
When you draft your partnership profit sharing agreement to be cognizant of how your partnership, and each partner, will be taxed on profit payments. Most partnership business profits or losses pass through directly to the individual’s personal tax returns. Thus each partner will add his share of the companies revenue or losses to their taxable income.
In addition, your partnership needs to file an annual tax return, called an information return, reporting sales, expenses, deduction and losses to the IRS.
How to Calculate Net Profits
When Not To Split Profits
Many fast-growing startups decide not to payout split profits amongst partners for these valid reasons:
Profit splitting is a major concern for business partners but is only one of the many decisions you need to decide with your partners, and document in your partnership agreement, before launching your new firm.
Once you and your partners are in accordance, then you are ready to start your business and generate profits to split with your partner as agreed.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Learn more on Business Partnerships 101 and about the pros and cons of starting a business with a partner. Also learn more about Profit Distribution.
Related Articles
The Pros and Cons of a Business Partnership
by Team ZenBusiness, on October 09, 2024
7 Tips for a Successful Business Partnership
by Team ZenBusiness, on August 15, 2024
Business Partnership Definition
by Team ZenBusiness, on November 01, 2024
Sharing The Wealth With Your Employees
by Team ZenBusiness, on August 29, 2024
LLC Profit Distribution
by Team ZenBusiness, on October 24, 2024
How to Write Business Partnership Agreements
by Team ZenBusiness, on October 16, 2024
Start Your LLC Today