How a Revenue Sharing Works in Practice
How Revenue Sharing Works in Practice
Small-business owners can pay themselves in a variety of ways, depending on how soon they need their money and what tax advantages they want to achieve. In addition to taking a salary, business owners can pay themselves with bonuses and commissions, or pay themselves using a distribution of profits or a revenue-sharing model.
Businesses can and attract more investment if they offer partners a revenue-sharing deal, points out Entrepreneur magazine. You can also pay employees and contractors using a rev-share model. Understanding the advantages and disadvantages of revenue sharing will help you make the best choice for receiving your income from your business.
What Is Revenue Sharing?
Revenue refers to all money that a business takes in, not just money from sales. Revenue can include sales, interest, investment gains, royalties, patents, leases and legal awards.
One form of revenue sharing refers to the principals of a business splitting all or part of a company’s revenue. That can include losses, as well as profits. Another form of revenue sharing is paying employees or contractors based on performance.
For example, some online businesses pay freelance writers a percentage of revenue their stories generate from readers clicking on ads. YouTube allows contributors who generate at least 1,000 subscribers to monetize their videos and generate money via revenue sharing.
Revenue Sharing vs. Profit Sharing
Don’t confuse revenue sharing with profit sharing, or you might be in for a nasty surprise at the end of the year. Profit sharing is a split of the profits, not revenues. This means you only get paid if there’s a profit, but you aren’t responsible for helping pay off any losses.
Make sure you understand all of the profit-sharing advantages and disadvantages before you consider going this route. For example, be careful to read the fine print of a profit-sharing agreement; some businesses try to charge as many expenses as possible to the business (including the owner’s salary) so there will be no profit left over.
If you want to set up a profit-sharing program for your management team or employees, make sure everyone knows what will be considered an expense to avoid any hard feelings.
You can set up a profit-sharing plan for employees that contributes the money to their retirement accounts. Whichever route you choose, ensure you follow IRS guidelines for these types of payments, advises Group Management Services.
You Can Crowdfund
If you’re trying to raise money for a startup, or to launch a new product or service for an existing business, you can generate investors if you promise revenue sharing. With a variety of online crowd-funding services available, you can post your project, give the specifics and attract investors who buy into your business in exchange for a piece of the revenues. You’ll need to work with a legal expert to set up your contracts, but crowdfunding opens your opportunity to raise capital to small investors you otherwise might not be able to reach, points out the University of Washington’s Foster School of Business.
Your Pay Fluctuates
One of the problems with revenue sharing is that you can’t earn a consistent, predictable income. This is because you won’t know whether or not there will be a profit from week to week, month to month or for the year, until after the fact. Even if you know your business will be profitable, you won’t know by how much. The shorter you can make your revenue-sharing period (e.g., monthly vs. quarterly) the quicker you’ll know your financial situation.
It Avoids Inflated Expenses
If you agree to a profit-sharing plan, you are the mercy of the people who decide what expenses are. If possible, ask for a share of the gross, not the net. This means you get a percentage of all revenues, regardless of whether or not the company makes a profit. This reduces the chances that you get cheated out of income by people who load up the company with questionable expenses like company cars, expensive trips and other perks. If possible, make sure you agree only to a revenue-sharing plan that doesn’t require you to pay back losses.
Employee Revenue-Sharing Issues
If you pay your employees, members or contractors using a revenue-sharing model, they are motivated to work harder, produce higher-quality work and avoid overspending. Be careful that they aren’t so motivated to cut expenses that they cut back on important expenditures like advertising and equipment maintenance. With a revenue-sharing model, you are also required to pay your stakeholders a percentage of your total revenues, even if you lose money.
