Searching for the phrase “what is revenue share?” will produce a host of articles describing the partnership arrangement and the benefits founders can realize. But, a more refined search “revenue vs profit share” will turn up far fewer articles.
That’s unfortunate because there are a number of key differences between revenue share and profit share, revenue share’s somewhat more complicated cousin. As a business owner, you really should consider each, and decide on the approach that best fits your business.
In this article, I want to lay out exactly what revenue share and profit share are, how exactly they differ, and the complications you may face with each so that you don’t make a major mistake when writing your partnership agreements. Let’s go!
Revenue Share vs Profit Share: What’s The Difference?
Revenue share is an approach to partnerships where a business splits the revenue received for a product or service promoted by an influencer or website; while profit share refers to the same sort of arrangement but where profits (revenue less direct costs) are split. The only real difference between the two is which line item the two parties agree to split: revenue or profit.
What Key Considerations Do Businesses Have To Keep In Mind When Opting For Revenue Share vs Profit Share?
Both profit share and revenue share agreements have to factor in the same elements – the difference is whether they are explicitly stated or not.
When to recognize revenue
Both revenue share and profit share agreements have to specify when revenue is earned, or recognized. This can differ substantially between products and services since product revenue is typically recognized when the product is transferred to the buyer, while service revenue is typically recognized as the service is rendered.
Both revenue share and profit share agreements need to specify when to recognize revenue so that payment to partners can be made in a timely manner.
The complications really begin when factoring in direct costs.
Direct costs associated with producing the product / service
While revenue is typically specified in either a revenue share or profit share agreement, direct costs are typically left out of a revenue share agreement, but explicitly stated in a profit share agreement. Since revenue share splits funds from a company’s topline (its revenue), there’s no need to calculate costs to arrive at a profit figure in the agreement.
While not stated explicitly, founders still need to keep costs in mind when structuring a revenue share agreement because you don’t want to agree to a revenue split where you’re taking in less revenue than it costs to produce the product or service.
In addition, if your revenue split is close to 50/50, you could end up with a tiny amount of profit on the product or service you are offering relative to your partner’s take.
For these reasons, it’s important to offer your partner a smaller percentage of revenue from each sale. You don’t want to be left either not being able to cover your costs or with next to no profit from the additional sales.
Profit share agreements make this consideration clear in the agreement itself. Rather than splitting the topline revenue, founders who opt for profit share agreements specify all costs associated with producing the product or service and split the amount that’s left over at the end. This ensures that all costs are covered and that you can negotiate a fair split of what’s left over.
The problem is that you have to have a very clear understanding of the direct costs associated with producing your product or service. It’s always good to know the numbers, but this can make profit share agreements things a bit more complicated and time-intensive to set up.
Inflation also complicates things. If the costs to produce your products or services rise, you could be looking at a smaller net amount to the business while your partner retains the amount of profit you specified in the agreement… or you could have to negotiate an updated agreement every year or so to account for the rising price level.
Alternatively, inflation may force you to raise your prices to cover your elevated costs. If you keep the existing agreement in place, your partner would maintain his or her gross payout amount but in less and less valuable currency. This could spark anger and end your partnership.
Trust between the parties when determining direct costs
While companies implementing revenue share agreements don’t suffer from this issue, those that opt for profit share need to have their partner’s trust when laying out costs in the profit share agreement.
Revenue share agreements just specify how much of the revenue each party will take. This is pretty straightforward and can be negotiated without laying out the actual costs involved in producing the product or service. In a profit share agreement, however, both revenue and costs are key numbers that have to be explicitly stated before even thinking about how to split what’s left over.
While revenue is pretty easy to determine by multiplying the sale price by the number of units sold, your partner has to really trust that you’re being honest about your cost numbers, or the agreement could be over before even discussing the profit split.
Revenue vs Profit Share: Which is Best For Startups and How?
If you know your numbers well, and your business process is fairly stable, revenue share seems to be the best for startups. It’s just simpler to structure a revenue share agreement since there are fewer moving parts to keep in mind.
You really have to have a good understanding of your direct costs, though, and have to be pretty sure that you won’t have to change your business process to produce your products or services, which would result in a change in your cost structure.
Another key factor to keep in mind, however, is what sort of agreement is standard in your industry. You’ll want to stick to the type of agreement that your potential partners expect – or you may not get any partners at all.
How I Structure Revenue Share / Profit Share Agreements
When we’ve opted for this marketing strategy, I’ve taken a hybrid approach that splits the difference between revenue share and profit share agreements.
Rather than laying out all of the costs associated with producing the product or service, I’ve laid out some of them – namely the payment processor and money transfer costs – and then split the resulting value between me and my partners.
This at least accounts for some of the costs that I’ll incur, but keeps things simple to prevent all the complications that come with determining exact costs and changes in costs. The actual percentage split has been – so far – fairly simple to negotiate.
How you decide to split the cash that’s coming in between you and your partner is really up to you, but no matter how you decide to go forward, you should understand the ins and outs and possible complications that you’ll run into.
Read next: Profit Share vs Equity Compensation: Will It Impact Your Company’s Growth?
