percentage split between partnership

[mitch]

I am entering into a two person partnership. We are currently trying to figure out how we should split the income percentage wise. My partner is investing all the money (about 10 thousand) into the company. It is a children's clothing company we are starting. I am a designer and I am taking care of all the production and design. Which means I have designed all the clothes and have arranged all of the manufacturers. I've basically done all of the work. Without my contacts and knowledge of the process my partner wouldn't be doing this so I am a valuable asset to my partner. Also, my partner is a very accomplished family photographer with a large following. the reason I point that out is because these clients are who we are going to marketing the product too.

My partner proposed that we do a 70/30 split. she gets 70 and I get 30 percent. I realize that she is taking a huge risk because she is investing and I have not invested any money but have provided the means and the knowledge to bringing it all together.

So I'm wondering what a fair split would be? Also would it be a good idea to actually do something like at 80/20 or a 90/10 split until she gets all of the money back that she invested, then at that point we would split maybe a 50/50?

I'm planning on investing everything I make back into the company so if everything goes well I will also be investing in the next season. So I can see a problem in the future when we are both investing money and I'm still doing most of the work. Any feedback on this would be much appreciated.

[Business Attorney]

A split does not have to be permanently fixed at a single ration. The alternatives are endless. For example, you could say that the distributions are 70/30 until she gets her original investment back and then the split becomes 50/50. Or it's 70/30 until she gets her money plus a 10% compounded return, then it goes to 50/50. Or it goes to 55/45. Or it starts at 80/20 or 90/10 like you have suggested.

The point is, there is no "right" or "fair" split. There are arguments for and against any particular split. I tend to think that a return to a capital partner that starts high and is reduced once the capital is returned more often reflects the true nature of the partnership, but that is not always the case.

[mitch]

Thank you for your reply. Could you explain more about what you mean by a 10% compounded return?

[Business Attorney]

By a 10% compounded return, I mean that the investor-member gets a 10% annual return, compounded over some period (in the case of equity investments, the compounding period is usually one year). This is in contrast to a 10% simple (i.e., not compounded) return. The basis behind the compounded return is the time value of money. When you carry an amount forward and pay it later, it is worth less than if you pay it today, so the compounding is intended to make up for that.

Here is an example where one member puts in $10,000:

Whether the return is compounded or simple, the amount owed to the investor at the end of the first year would be $1,000 (10% of $10,000).

Like many startups that cannot afford to spare any cash to make a distribution in the early years, this LLC pays the investing member nothing in year 1. If the rate is compounded, at the end of the second year the LLC will owe the investor an additional $1,100 (10% of $10,000 and 10% on the $1,000 which was not paid in year 1). At the end of year 2, the LLC would owe the investor a total of $2,100 plus his initial investment ($1,000 from year 1 and $1,100 from year 2).

In year 3, the same logic would apply and the LLC would owe the investor $3,310 at the end of the year ($1,000 from year 1, $1,100 from year 2 and $1,210 from year 3), plus his initial investment.

If the amount owed to the investor was not compounded, you would just owe $3,000 ($1,000 for each of the 3 years), plus his initial investment.

[Spider]

You ask about splitting the income. I suggest you do not split the income. The income is the income of the company, not of the principals. Pay yourselves a salary. Salaries would reflect the work input expected of each partner. Salary, along with other espenses, is deducted from total income to determine profit. At the end of the year, split the profit.

My view of the value split between money and labor is 50/50. Money doesn't produce anything without labor and labor doesn't produce anything without money. They are each needful of the other = 50/50

In this case, both partners are bringing other foundational value to the business at creation - list of prospects by one partner, industry contacts by the other partner. One is as necessary as the other = 50/50.

You have not stated who will do the work of the business (primarily marketing and the design and production of product.) As the photographer partner has a successful ongoing business and there is no mention of an ongoing business by the design partner, I am assuming that the work of the business will be done by the design partner.

Therefore, in this scenario, one partner is supplying the money and the other partner is doing the work, with foundational value being provided equally, I believe a fair split of profit would be 50/50 with salaries being paid appropriate to the work being done.

This does not provide for the money ever being paid back (until the business is liquidated.) That is what an investment is. If it is contemplated that the money is to be paid back, it is a loan and should be treated as such with a proper loan contract being set up at the outset. This would create totally different considerations regarding split of profits.

[Steve B]

The reality is that you are likely going to lose money the first few years. It's not as easy as just splitting up the piles of money you're going to be making. How are you going to handle the losses? In 6 months, you may find that someone needs to chip in more money just to pay the bills. I'm just giving a reality check here - you may be a long way away from splitting any profit (or even taking a salary).

[Spider]

Good observations, Steve. I was allowing that the partners had done their homework and the initial investment would be sufficient to get the business started without need for additional funding. That's what I did with my start-up. But, it is certainly true that initial calculations can be overly optimistic.

[Business Attorney]

There are also some very capital intensive businesses and some at the other end of the spectrum that need very little capital but lots of talent and labor. While 50/50 may be a rule of thumb, it is just that. There is no "one size fits all" when it comes to splitting partnership profits.

Also, the salary needs to be taken into account. If the working partner is being paid full value for his services, plus 50% of the profits, while the capital partner is only getting 50% of the profits, what is the working partner actually contributing? In many businesses, a reduced salary (at least for some period) is the "equity" in "sweat equity." Alternatively, the capital partner gets his original investment out with a reasonable return (but not at a venture capital return rate of 35-40%), the working partner gets a reasonable salary, and they split what is left over.

[Spider]

There are also some very capital intensive businesses and some at the other end of the spectrum that need very little capital but lots of talent and labor. While 50/50 may be a rule of thumb, it is just that. There is no "one size fits all" when it comes to splitting partnership profits.... I agree, David - there is no 'one-size-fits-all. I don't think 50/50 is even a rule of thumb. That's why I gave my reasoning to show why I felt 50/50 was a reasonable split is this case. Of course, there may be other factors that the OP did not explain that could change that.



... Also, the salary needs to be taken into account. If the working partner is being paid full value for his services, plus 50% of the profits, while the capital partner is only getting 50% of the profits, what is the working partner actually contributing? In many businesses, a reduced salary (at least for some period) is the "equity" in "sweat equity." Alternatively, the capital partner gets his original investment out with a reasonable return (but not at a venture capital return rate of 35-40%), the working partner gets a reasonable salary, and they split what is left over.What is the working partner contributing? Why, they are (in this case) creating the profit. They appear to be creating the profit single-handedly using the capital partner's money.

I realize that one might argue that the working partner will be getting paid for their work by way of salary, but that does not deny the fact that the working partner is creating the profit, and in a partnership should share in that profit. (Otherwise, it is more an employer/employee relationship than a partnership.)

OTOH, the capital partner puts the money in only once and gets paid a profit share year after year, for a single payment at the beginning.

It could be that the capital partner will be doing some work - perhaps the marketing, as the marketing seems to be focussing on the capital partner's client list. In that case, I see the capital partner receiving a salary - perhaps a part-time salary, because they will be spending most (?) of their time in their other business. That doesn't break the 50/50 relationship between money and labor.

It would affect the amounts each partner receives, though. The working partner would receive her share of the 50% profit allocated to labor (if she does 90% of the work, she would receive 90% of 50% - 45%) while the capital partner would receive 10% of the 50% profit allocated to labor (5%) + the 50% of profit allocated to capital - 55% total. This maintains the 50/50 relationship between capital and labor.

[vangogh]

Everyone is making some good points. I think the even split, in this case 50/50 is the usual starting point, but each partnership is really different. I think you have to take a deep look at what each partner is going to contribute to the business both at startup and after some time in.

There are so many things to consider and in the end you both have to decide what's fair for each of you.

To start your partner will be contributing $10,000. Certainly a significant amount of money to risk losing, but at the same time hardly a huge investment for a business. Will your partner be contributing more as the business needs it? How much? How often? I don't think a one time investment of $10,000 is worth 70%. If you own a credit card or two you likely have access to that same amount of money. Which would you rather pay? Interest on the card of 70% of the business.

However…

You mentioned your target market is selling to your partners existing clients. That to me is worth more than the initial investment. That could be worth 70% of the business by itself depending on how many clients we're talking and the likelihood of them buying from your business. You'd also have to consider how many sales you could or couldn't make without her clients.

If I'm understanding right you're going to be doing all the work. If that is the case then as time goes on your value to the business increases. What sounds fair today may not sound so good 2 or 3 years from now. David's idea that the split can change over time could work best if your partners contribution is mainly going to be the initial investment and access to clients. Of course your partner may continue to bring in new clients to the business from other business ongoing.

What I'm saying is there's a lot to consider. You have to look at what you're both contributing at start up and what you'll both be contributing a few years down the line and also when revenue and profit is likely to come in.

[huggytree]

anything long term short of 50/50 = end of the partnership someday.....most partnerships ive known fail...very few continue....those that i know of that succeed are because both partners are extremely easy going.....if your competitive in anyway = failed partnership in my opinion

i think its very fair to go 70/30 until the investment is recouped....i wouldnt give any interest....your each bringing different things to the table and neither should be rewarded extra.....after she's paid back you MUST go 50/50 otherwise your partnership has no chance....

i also agree with Steve B that you may go a year or 2 w/o profit...you may be 70/30 for 10 years...........are you prepared for that? you may never make profit....

[Spider]

Or you may be profitable from the third month onward.

[huggytree]

i made enough to survive full time after 8 months of being part time/while for someone else......i dont think many businesses are profitable in 3 months...could it happen..YES.......will it happen...probably not....

being overly positive is not what i recommend when starting out....being as conservative as possible and planning for the worst is where i recommend starting.....

being out of business in 3 months is more likely than being profitable in 3 months.......this economy is not a good time to start anything....im still having small business friends go under every month or 2.....id say over the last 3 years 33 percent of my small business friends went under.

[Spider]

My wife's pet grooming business was profitable in the second month. My own plumbing company was profitable in four or five months, by which time we probably had 10 or more employees. It's not a question of being overly positive - it's a matter of doing your homework, planning ahead, and being more efficient than your competitors.

And while the grooming business wasn't a partnership, the plumbing company was, on several levels, and was profit-sharing, not only between the partners at differing percentages, but with all the employees, too.

[BRACKEN]

Hi, My wife and I have a 50/50 split partnership in our guest house but my tax is used up and she pays no tax. It was ok last year because we made a loss but this year we are likely to go into profit. Can I change the split to 99% wife who pays no tax and 1% me? The building is owned 50/50 Thanks Trev.

[Lewis-H]

Partners share in the profits and losses to the extent of their share in the business. If each contributes 50 percent of the start-up money, then each is entitled to 50 percent of the profits, according to Weltman. ... Rules concerning voting, admitting new partners, and management.