Today we are talking about partnerships, and specifically, how do we allocate profits among the partners? What do we do when all this money’s coming in and we’re greatly successful? How do we divide that up and make everybody happy? The answer is, we get to pick.
Under our state laws, generally we get a lot of discretion in our agreements, whether it be an LLC agreement, a partnership agreement, even in a corporation, by using salaries and other metrics and methodologies of paying, we can get a lot of flexibility in dividing how the money goes among the partners. But the key is to have an understanding. How’s the money going to be divided in a profit situation? How’s it going to be divided in a loss situation? And what do things look like over a range of events?
One place we find a lot of people make mistakes is they don’t plan for what’s going to happen if there’s an unusual event. If the profits are in the expected range, usually people run a lot of “what if” scenarios. What if there’s a wildly profitable year? What if there’s a big loss year? How would that affect the partnership allocation? We want to dig through all of that before we start the company because we really don’t know what’s going to happen in the life of the company and we want to understand it.
A lot of times, people build profit allocation provisions based on the number of hours worked, money put into the business and the division of the ownership at the end of the day. There can be a lot of different ways to allocate it, and there is no one answer.
We want to look at what’s unique for the partners. Are the partners possibly going to work a different number of hours, either now or in the future? Has one of them put in more money than the other? Are they putting in differential effort or skills? Is one more valuable than the other? All of these things can come together and create a blended formula.
What we want is a very specific methodology to divide that money among the partners, so that there’s no uncertainty at the end of the day about how everybody’s going to divide the money, or how the business is going to do business. And bringing that all together, we end up in a great spot. So we want to build a custom allocation that really reflects you. There are a lot of options out there. You will want to look at what other partners are doing and decide what really fits you. Then go to your lawyer, and your lawyer can easily document that in a way that makes sense for you and your business. Are you dealing with issues like this? Has this been a problem?
Each case is unique. Past results do not guarantee future outcomes. This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. Each case is unique. Past results do not guarantee future outcomes. This article should not be treated as legal advice to any person or entity. FreeImages.com/photographer Manu Mohan.
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