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To position themselves for long-term success, companies need to establish the right business model. Focusing on future growth potential often involves sharing some of the company’s revenue as part of a strategic plan.
What is Revenue Sharing?
Revenue sharing is an arrangement between two or more parties sharing a portion of a business’s profits and losses. This type of agreement is often seen between companies and partners (e.g., suppliers, distributors, etc.) and within companies themselves.
Sharing business profits is common practice throughout various industries and contexts. Here are a few examples:
- Software As A Service (SaaS): In the SaaS industry, revenue-sharing agreements are common between platform providers and third-party developers who create software applications for the platform. These developers receive a share of the revenue generated from the sale of their applications.
- Affiliate Marketing: Most companies establish revenue-sharing partnerships with affiliate marketers who promote their products or services.
- Franchising: Franchise businesses share revenue between franchisees and franchisors. In this arrangement, the franchisee pays the franchisor a percentage of their revenue in exchange for the right to operate under the franchisor’s brand and access their resources and support.
- Profit Sharing: Many companies offer profit-sharing plans to their employees, distributing a portion of their profits to eligible workers.
- Joint Ventures: In joint venture agreements, two or more companies collaborate on a specific project, sharing the profits and losses. They combine resources and expertise to achieve a common goal, often leading to innovative solutions and new business opportunities.
- Governments and Financial Institutions: Governments often enter into revenue-sharing agreements with financial institutions, allowing them to operate within a jurisdiction in exchange for a portion of their profits.
The revenue-sharing business model is somewhat flexible, taking different forms depending on a company’s structure, product offerings, and market conditions. Companies may share all or some of their profits and losses with partners, employees, investors, or any combination of the three.
- Revenue sharing program: A program available to partners, customers, and/or employees on an opt-in or as-required basis, where they share in the company’s profits or losses in specific facets of the business.
- Revenue sharing business model: A business model in which companies share both operating profits and losses among stakeholders.
- Revenue share: The amount of revenue shared between two or more parties, typically expressed as a percentage of total profits.
How Revenue Sharing Works
The practical details of every revenue-sharing plan might be wildly different, but the main concepts of revenue sharing are pretty consistent across verticals.
There needs to be an agreement between two or more parties that outlines the terms of the arrangement. This agreement should specify the percentage of revenue-sharing payments each party will retain and how disputes will be settled. It should also detail direct and indirect costs and expenses associated with the agreement.
All participants in the revenue-sharing program need to keep detailed records of the income and expenses associated with their specific contributions to the partnership. This will ensure that everyone is fairly compensated for their work.
The company needs to consider how revenue sharing affects taxes. Depending on the structure of the agreement, each party might be responsible for paying some or all of the applicable taxes on shared revenues.
For example, if a software company establishes a revenue-sharing partnership with an app developer, they might agree to split the profits generated from sales of their applications 50/50.
In this arrangement, any costs incurred by either party would be subtracted from their respective shares before payments are distributed.
Both parties would also be responsible for paying any applicable taxes on their respective share of revenues.
Benefits of Revenue Sharing
There are a few reasons an organization would choose to share revenue with others:
- Incentivizes new sales contracts. Aligning the interests of all parties involved fosters a sense of ownership and commitment to the company’s revenue growth.
- Brand advocacy. If customers can share revenue from new deals, they’re more likely to become brand advocates and refer additional customers.
- Attracting and retaining talent. Offering a share of the profits as part of an employee’s compensation package makes a company more attractive to job prospects.
- Risk mitigation. Sharing profits and losses distributes risk more evenly. This arrangement encourages collaboration and incentivizes both parties to minimize risks and maximize profits.
- Expanding market reach. By sharing revenue with established players in target markets, businesses lower entry barriers and improve their chances of success in new regions.
- Encouraging innovation. Distribution of revenue to partners and employees leads them to develop new products or improve existing ones to help the company gain a competitive edge.
The bottom line: Sharing revenue among stakeholders might reduce the actual revenue a business takes for itself, but it’s an effective strategy for building sustainable revenue over time.
Types of Revenue Sharing
There are four main forms of revenue sharing: profit-sharing, the revenue share model, incentive programs, and mutual funds.
A profit-sharing plan is a simple form of revenue sharing in which profits from the business are shared among its stakeholders. The amount distributed to each party depends on their specific contributions.
Companies using this form of revenue sharing typically fall into one of these categories:
- Small businesses that depend on one-time customers for revenue.
- Project-based businesses that offer services based on a fixed fee or hourly rate.
- Companies with solid profit margins and enough cash runway to expand and grow new revenue streams.
Usually, the terms of profit-sharing plans include a set percentage of profits to be distributed among the stakeholders involved.
Since they are based on bottom-line profits and not gross or net sales, they are less risky to partners than other forms of revenue sharing—that is, they don’t entail direct costs.
Revenue Share Model
The revenue share model is a form of revenue sharing in which companies grant a percentage of their revenues to external partners for providing services.
This model works especially well with software companies businesses, as they rely heavily on third-party developers and marketing firms to help them grow their customer base.
Most organizations using the revenue share model fit one of these profiles:
- Businesses with long-term contracts and recurring revenue from customers.
- Corporations with a large user base and relatively low customer acquisition costs.
- Organizations that use third-party services to grow their customer base.
- Companies that need to offset their risk to make growth more feasible.
- Smaller firms looking for ways to monetize products or services without investing in marketing or development teams.
Unlike profit-sharing plans, the revenue share model is based on gross sales and can include operating expenses.
The amount distributed to partners depends on their contribution to the company’s growth or success over a set period of time.
A revenue-sharing program based on incentives is a way of rewarding employees or customers for their loyalty and contributions to the growth of the business.
Companies with long-term customer relationships, such as subscription-based businesses or large enterprises often use incentive programs.
These organizations typically reward key stakeholders in exchange for continued patronage or engagement. Rewards could come in the form of one-time cash bonuses or product discounts.
Incentive programs work well for companies with a large customer base, as they help to reduce customer churn and build loyalty over time.
They also make sense for high-growth startups in need of capital but have limited access to funding.
Mutual funds are revenue-sharing funds that pool money from different investors to invest in a variety of securities.
They allow smaller investors to access a wider range of investments than they could on their own. They also help reduce risk by diversifying across multiple investments within the same fund.
Investments in mutual funds include:
- Real estate investment trusts (REITs)
- Money market instruments
This form of revenue sharing is particularly popular among high-net-worth individuals or organizations that already have sustainable growth and can diversify their portfolios.
The amount each investor receives is determined by the mutual fund’s performance over time and the percentage of their contribution.
Mutual funds are often managed through a financial institution (i.e., a brokerage firm) and require significant up-front capital.
Factors That Influence Revenue Sharing
Multiple factors impact the success of a revenue-sharing agreement. When setting up such an arrangement, it’s important to consider the following:
Federal Government Regulations
The Securities and Exchange Commission (SEC) regulates the financial services industry, ensuring revenue-sharing agreements in this sector are transparent and legally compliant.
The Federal Communications Commission (FCC) bans certain agreements between building owners and telecommunications providers.
ERISA regulates revenue sharing in reference to the splitting of funds between 401(k) providers and mutual funds. The law sets guidelines and regulations for fiduciaries and investment companies to avoid misusing plan assets.
Antitrust laws are designed to prevent anti-competitive practices and maintain fair market competition. These regulations can also affect revenue-sharing agreements, as companies must ensure that their arrangements do not lead to monopolistic behavior or other unfair competitive advantages.
Another factor to consider is the administrative costs of running a revenue-sharing agreement.
Depending on the size and scope of the arrangement, companies may need to hire a third-party administrator to manage payments, track performance metrics, and ensure compliance with applicable regulations.
Any income generated from a revenue-sharing agreement will be subject to taxation.
Companies must ensure that the revenue-sharing arrangement complies with local tax laws and properly recognizes revenue earned from the agreement.
How to Structure a Revenue-Sharing Agreement
Revenue-sharing agreements vary wildly based on business needs and organizational structure.
Briefly, here’s an overview of how to structure one:
- Identify the revenue sources and stakeholders
- Define each party’s responsibilities and define a timeline for payment
- Set measurable performance metrics that will be used to assess success
- Consider any applicable government regulations
- Estimate administrative costs associated with managing the agreement
- Ensure compliance with tax laws
- Create a contract that outlines all terms and conditions
- Sign the agreement
Tracking Revenue Sharing
With process automation, it’s easy to track revenue sharing. Use the following business software to monitor and manage the agreement:
- Accounting Software: Track revenue, expenses, and profits associated with the agreement.
- CRM Software: Manage customer relationships that are part of the agreement.
- Project Management Software: Monitor performance metrics against agreed-upon timelines.
- Partner Relationship Management (PRM) Software: Monitor partners’ and vendors’ performance and maintain communication.
- Document Management: Keep track of contracts and other legal documents related to the agreement.
People Also Ask
What is the difference between revenue sharing and profit sharing?
The main difference between revenue sharing and profit sharing is that revenue sharing involves distributing income based on a percentage of total sales, while profit sharing distributes profits after costs have been taken into account. Revenue sharing usually requires partners to absorb costs associated with generating that revenue.
What is a typical revenue-sharing percentage?
A typical revenue-sharing percentage is between 2% and 10% of total sales revenue.
What is an example of revenue sharing?
An example of revenue sharing: Two companies enter into an agreement whereby Company A (the licensor) provides its product or services to Company B (the licensee). The licensee pays a portion of the revenues from the licensed products or services back to the licensor.
How do you calculate revenue sharing?
Every business has its own method for optimizing its revenue share model. The factors they account for are:
* License fees, royalties, discounts, incentives, and other revenue-share components
* Operating costs and expenses
* Administrative costs
* The company’s profit margins
* Growth potential of the product or service
* Tax implications