App version: 0.1.0

How to Split Profits in a Small Business Partnership

How to Split Profits in a Small Business Partnership
Lauren Ward

Lauren Ward

Updated December 27, 2021
Share this article:
Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
When you go into business with someone, one of the factors you need to consider is how you will share profits and revenue among the partners. It can be a good idea to discuss and settle this issue in an official, legal way before you start your venture, since it will affect how you set up your company and your tax requirements.When deciding how to divide profits in a business partnership, there are a number of variables to consider, including the number of partners involved, how much responsibility each person will take, and how much each partner is contributing financially. Here, we take you through the process.

Considerations When Splitting Profits in a Small Business Partnership

There are many different ways to split profits. It can be as simple as splitting them evenly down the middle or offering a base salary plus split profits. You can also involve other variables like equity, commissions, bonus, and more. Before making a decision on what’s right for your company, you may want to consider: 
  • How many partners will be involved in the business
  • How the company's shares and ownership will be split
  • The roles and responsibilities of each partner 
  • Daily and weekly time each partner will contribute
  • Amount of startup and working capital each partner will invest
  • Skills and amount of experience of each partner
As you try to determine an equitable way to divide profits, you may want to keep in mind that business contributions can take many forms. One partner might be offering more of their time, while another might have critical experience, and another might be putting more of their personal savings into the business. There are no rules for how valuable each is, and it’s entirely up to you and your partners to decide on a profit split that everyone agrees with. Recommended: Gross Profit Margin and How to Calculate It 

Small Business Partnership Structuring Options

Choosing how to split profits in a small business partnership often revolves around the type of structure your business has. Below are common options to consider. 

General Partnership (GP)

A general partnership is when an unincorporated business (meaning a business that is not legally separated from its owners) has two or more owners that share responsibilities. Unlike other structures, each partner in a partnership can be held liable for any debts or other obligations related to the small business. Unless the partners request differently, this type of partnership assumes a 50-50 split of management duties, liabilities, and profits. If one person plans on contributing more time or financial resources than another, this should go into the documentation right away. There are a number of benefits to forming a general partnership. One of the biggest is that it can be relatively easy to form because it requires very little documentation. If you’re in a time crunch, you can get going very quickly. 

GP Taxes

Compared to other business structures, taxes for a general partnership are relatively simple because the business is not required to file a return separate from the owners. Instead, each partner must simply report both profits and losses on their personal tax return.However, in addition to filing personal tax returns, each partner must also submit a Form 1065 for the business, which is purely informational and lists things like credits, deductions, income, gains, and losses. 

Limited Liability Corporation (LLC)

The LLC structure provides more protection than a general partnership because it protects your personal assets should you run into any legal troubles. It also protects all partners from personal liability for business debts if the business fails. By default, all profits are split equally among all partners. However, like a general partnership, you can change the amounts to anything you want provided you put it in writing.

LLC Taxes

A multiple-member LLC can choose to pay taxes as a partnership firm, in which the LLC’s earnings are passed straight through to the owners, without having to pay corporate federal income taxes first. Alternatively, it can choose to be taxed like a corporation. This has the advantage of receiving the same favorable tax rates the Internal Revenue Service (IRS) gives larger corporations. The downside is double taxation as profits move through the business and to the private individuals connected with it. 

Limited Partnership (LP)

A limited partnership is a hybrid of the two options above. It is composed of two or more partners: The general partner, who oversees and runs the business, and the limited partners, who can invest in the business and share in its profits or loss, but cannot be active participants in the day-to-day operations of the company. The general partner can be held personally liable for any business debts and obligations. A limited partner typically does not have personal liability for partnership obligations.

LP Taxes

LPs are taxed in the same way as GPs. However, limited partners may be subject to slightly different tax treatment than general partners, so it can be a good idea to consult an accountant or other tax professional for more detailed guidance.

Decide How to Split Profits

How you decide to split company profits is up to you and your partner(s). There isn’t a legal rulebook anywhere you have to follow. You may decide to pay each partner a base salary and then split any remaining profits equally, or assign a percentage based on the time and resources each person contributes to the company. 

Divide by Responsibility

You may decide the one partner is running the show more so than other members. If this is the case, everyone may agree that they should get a majority share. Just how much you decide on depends on what you all agree on. 

Consider the Capital Contributed to the Partnership

If you are able to contribute a sizable amount from your personal savings and are the only one to do so, then it may be fair that you should receive more profits than your partners. However, if other partners are opposed to this, another way to obtain small business funding is to get a small business loan or grant so no one has to put any of their own money in. A business loan makes everyone equally responsible for the payments.Recommended: How Do You Find Venture Capital for a Startup?

Best Practices for Splitting Profits in a Business Partnership

Put Everything in Writing

Once you know how you plan on splitting profits, it’s a good idea to make it official. This involves formalizing both your business and the profit split agreement in writing. This document can include:
  • Individual contributions to the small business. Has one of you given personal money to the formation of the business? If so, how much? Who obtained the equipment? Whose property is the business located on? 
  • How profits are to be divided. A 50/50 partnership may or may not be appropriate. You might opt for a 70/30 profit division or other ratio that makes sense. The important thing is that everyone agrees on it and that you put it into writing.
  • Which decisions partners can make independently and what must be referred to the group. To avoid as many disputes as possible, it can be smart to decide early on who makes what types of decisions, be they vendor disputes, hiring and firing employees, or day to day spending. You may want to write down what types of authority each of you has so you both understand the chain of command in all situations.   
  • How responsibilities are to be divided. Who does what and when? Who is in charge of things like payroll, advertising, or scheduling? It can be a good idea to also have this in writing. 
  • How you intend to raise money. Your capital structure may depend on debt, equity, or both. It can be wise to decide on what you intend to pursue early on and put it in writing.  
  • What happens if a partner dies, retires, becomes disabled, or is otherwise absent. What happens to a partner’s equity when they leave? Are the other partners required to purchase those shares?

Disadvantages of Business Partnership Profit Sharing

A lot of things can go wrong when splitting profits. Here are some of the potential downsides of small business partnerships:
  • Loss of Autonomy. In an equal partnership, you share profits as well as control of the business with a partner and important decisions would be made jointly.
  • Increased liability. General partners retain full liability for their own actions, as well as all other general partners. That means, you’re responsible for decisions your partner makes in connection with the business.
  • Future selling complications. As circumstances change in the future, you or your partner may wish to sell the business. This could present difficulties if one of the partners isn't interested in selling.
  • Losing a partner can be costly. You will have to value that person's assets, plus replace an essential person who has taken on a lot of responsibility.
  • Partnerships can easily collapse. If a general partnership has no provision regarding what happens if a partner leaves, then the partnership collapses if any partner exits or dies.

The Takeaway

Entering into a business partnership can be exciting. But before you start investing a lot of time and money with this person, it can be wise to take a step back and look at the small business partnership from all angles, including how you’ll divide profits. The answer may be as simple as splitting them evenly or offering a base salary plus the split profits. There’s no right or wrong answer. What matters most is that all partners agree to the arrangement and that you put the details of your agreement in writing.In addition to deciding how you divide profits, it can also be a good idea to determine how you will finance your business, such as whether you will invest your own money in equal amounts or if you’ll seek outside financing.If you want to investigate different kind of business loans for your partnership without making any type of commitment, Lantern by SoFi can help. With our online lending platform, you and your partners can explore rates from multiple small business lenders with just one application.
Photo credit: iStock/SouthWorks

About the Author

Lauren Ward

Lauren Ward

Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
Share this article: