Entrepreneurship: How to Divide Profit & Loss
Many entrepreneurs operate as sole proprietorships with one owner. Other small businesses have multiple co-founders and owners. With multiple owners, a company must split its profits and losses appropriately. The solution depends on the company and its owners and what they think is best for them.
When two or more people join together for the purpose of conducting business, they automatically form a partnership. You can formalize this general partnership by drafting a partnership agreement. Alternatively, you can register as a limited liability partnership if your business provides a professional service and you or the majority of your partners are licensed in that profession.
You can also file articles of organization to become a multi-member LLC whose operational oversight can be documented in an operation agreement. Another possibility is to file articles of incorporation to create and operate as a corporation. With S corporations, you document ownership rights and profit-and-loss distributions in the buy-sell agreement or shareholder’s agreement. Regular, or C, corporations pay taxes at the corporate level, so dividends go to shareholders instead of actual profits and losses.
When you form a company with one or more individuals, you not only must decide who will have what duties but also determine who will get what profits. You may decide to split profits according to each owner's equity participation in the business, or you may decide to distribute them based on how much each owner contributes to the ongoing success of the business. Because the determination of profit and loss splitting could be contentious or could change over time, documenting the decision in the appropriate business document is ideal.
If one or more owners are employees, as owners you may decide to pay the employee-owners a fair market salary and provide them with bonuses for the work effort they provide. You may also provide them with retirement benefits as the business grows. By doing this, you can still split your company’s actual net profit according to percentage ownership while additionally compensating those owners who actually work in the business.
ABC Company has five owners. One owns 40 percent while the other four own 15 percent. Two of the owners are active in the business but that compensation is governed by an employment agreement. ABC’s written policy is to distribute profits and losses according solely to percentage ownership. ABC decides to distribute 50 percent of its $500,000 net income to owners and retain 50 percent to grow the company. Of the $250,000 distributed to owners, the 40 percent owner receives $100,000 while the other owners each receive $37,500.