How to Handle Distributions, Allocations, and Profit/Loss Division in Partnerships

If you’re entering into a new business partnership, you should decide how you’re going to split profits and losses between partners before you start making money. You don’t want to find yourself fighting over debts after the fact. The best way to avoid partnership disputes over profits and losses is by planning their allotment in your partnership agreement.

Without a partnership agreement in place, equal partners assume profits and losses equally. This might work in some cases, but partners with absolutely equal power risk running into a decision-making stalemate that could derail their partnership.

Partnership profits and losses are often distributed based on capital contributions and management responsibility. General partners take on greater personal risks and are often rewarded with greater profits to reflect their precarious position, while limited partners are shielded from liability beyond whatever they’ve invested in the partnership.

Technically, your partnership’s profit and debt-sharing ratios could be whatever arbitrary numbers the partners agree upon – as long as you specify the terms in your partnership agreement. Your arrangement should reflect the investments made and risks taken by each partner in the venture so that nobody feels shortchanged when it comes to profit distributions.

A qualified business attorney can help you weigh all of the relevant factors and come to a profit- and debt-sharing agreement that sets up your partnership for success.
How Can Partnership Profits and Losses Be Distributed?However you decide to divide your profits and losses, you should clearly lay out these terms early on in your partnership, ideally in your partnership agreement. Unless you specify otherwise, the law will generally divide profits and losses equally between equal partners.
Many factors can affect how a partnership splits its profits and losses. The amount each partner gets will depend first on whether they are a general or limited partner.

• General partners tend to take on more of the risks so they often get more of the profits. In the case of debts, general partners are personally liable for a partnership’s losses. Also, general partners tend to be actively involved in managing the partnership’s operations, contributing more time and effort than limited partners.
  
• Limited partners are only liable for the amount that they invest into the partnership. Unlike general partners, their personal assets are off limits to the partnership’s creditors. Limited partners also tend to have less management responsibility. Compared to general partners, limited partners often get a smaller proportion of the partnership’s profits.
  

A partner’s contribution to the partnership could take the form of:

• Money or capital – Many partnerships are formed because one partner has the ideas but not the money necessary to see them through. In your partnership agreement, you could include terms for profits and losses to be divided based on the ratio of capital contributed by each partner over the course of that year. So the partner who contributes the greatest capital will get the greatest proportion of profits.
  
• Knowledge or resources – While one partner may be contributing financially, another could bring valuable information or resources to the table. One partner’s patent or copyright could be worth just as much as or more than a significant capital contribution. One partner’s professional expertise could be critical to the success of the partnership, where the partnership would fail without their knowledge or industry connections. Your partnership agreement could split profits to reflect this value.
  
• Time and effort – Even if one partner brings in a significant chunk of capital, another might spend dozens of hours every week to ensure the success of the partnership. They may act as the partnership’s boots on the ground, making sure the business operates on a day-to-day basis as well as keeping on track to meet long-term goals. You can reward their time and effort by reflecting that value in the partnership’s profit-sharing agreement.
  

There is no one-size-fits-all approach to profit and loss sharing in business partnerships, which is why templates you might find online will often fall short. The arrangement you and your partners agree upon should depend on the unique circumstances of your partnership.
Examples of Profit and Loss Distribution in PartnershipsYour loss distribution and profit-sharing agreements make up two important parts of your partnership agreement. Ultimately, your partnership agreement should show a full picture of your business arrangement: the number of total partners, the responsibilities and contributions of each partner, and the liabilities each partner takes on.
Some common examples of profit-loss sharing scenarios may look like:

• Partner A and Partner B each contribute $100,000 in forming a business partnership. Partner A manages all of the day-to-day operations while Partner B is a silent backer. Because Partner A has greater responsibilities, their partnership agreement states that they will share losses equally but Partner A will receive 80% of the profits.
  
• Partner A contributes $200,000 while Partner B contributes $100,000 to their new partnership. Both are equally responsible for managing the partnership’s day-to-day operations. Their partnership agreement states that profits and losses will be divided in proportion to the amount in each partner’s capital account on the last day of the year.
  
• Partner A contributes $200,000 while Partner B contributes $100,000. Partner A is responsible for day-to-day operations while Partner B handles upper-level management. Their partnership agreement states that Partner A will take on 70% of the profits and losses based both on their greater capital contribution and because their responsibilities require a greater amount of time and effort compared to Partner B.
  

The hypotheticals can go on and on. If your partnership receives contributions beyond cash capital, you may have to bring in expert appraisers to properly determine what they’re worth. You may need appraisers for real estate, office space, patents, trademarks, copyrights, office equipment, machinery, or other technologies that partners bring to the table.
You can also revisit your profit-sharing and loss-sharing agreements as your partnership grows. You can always update these agreements to reflect changes in your business.
The best approach is to come up with a profit and loss distribution model that makes sense to you. It’s best to do this early on in your partnership, ideally with the help of a business attorney who has experience evaluating partnership contributions. Call the Philadelphia area offices of Holmes Business Law now at 215-482-0285 or use our contact form to get started.