Learn more about the pros and cons of revenue sharing, whether it is the right revenue model for you, and how to draw up a revenue sharing agreement.
Revenue sharing takes several forms, although each iteration involves an agreement between associated financial actors to share operating profits or losses. Sometimes, it's an incentive program where a small business owner pays associates or partners a percentage-based reward for a service or action that boosts sales, subscriptions, or the bottom line—for example, referring new customers.
So how does revenue sharing work?
Let's take the example of the ecommerce industry. The growth of online advertising models has led to a form of revenue sharing called cost-per-sale. It rewards every participant within an advertising network that contributed towards making a sale happen. Other revenue sharing examples include:
- A freelancer or professional sharing their expertise to a startup to help grow the business in return for a percentage of the revenue earned as a royalty fee
- Government units sharing tax revenue
- Investors or stakeholders entering into a revenue-sharing agreement with a business—for example, banks issuing loans to the business
- Co-owners of a business
What is revenue sharing?
Revenue sharing is a performance-based income model that involves sharing business profits or losses among participating partners. Revenue sharing is a profit-sharing system that ensures all parties involved are compensated for their contribution to the business.
Is revenue sharing for everyone?
No, revenue sharing is not for everyone. Moreover, since the businesses and the parties to the revenue-sharing deal share either the profits or losses, it is not a steady income source.
From the revenue-sharing definition above, you can think of it as a commission-only agreement with no base salary where you only get paid if your efforts and expertise bear fruits. Therefore, it is best to implement it as supplemental income. On the other hand, the fee-for-service businesses model offers a more reliable revenue stream.
Revenue sharing plan: pros and cons
All business partnerships have risks, which you can only mitigate when all parties have each other's best interest in mind. The pros of a revenue-sharing plan include:
- The goals between participants align toward generating sustainable revenue
- Higher productivity since the parties involved focus on shared success
- Having a stake in the business creates worker loyalty
- Since it's a performance-based model, it incentivizes the partners who bring in the skills
- Companies can scale revenue-sharing payment models without additional capital injections
The biggest con of a revenue-sharing plan is it lacks a consistent, predictable income. However, you can mitigate it by shortening your revenue sharing period.
What is the difference between revenue sharing vs. profit sharing?
Revenue sharing refers to a top-level income split between associated parties—generated from the sale of products or services. You can also refer to it as a commission-only agreement where the parties share the profits or losses. In contrast, profit-sharing deals split the company's profits—the total revenue left after subtracting all costs.
How to structure a revenue-sharing deal
The key to landing a fantastic revenue-sharing deal lies in its structuring. The foundation should be solid and performance-based to motivate associated parties to increase productivity. Everybody gets paid when the business earns more.
The margins for information businesses are notably higher than the ecommerce sector. Therefore, you can agree to structure at a higher percentage for the former and concentrate on increasing volume for the latter to attract top skills. However, it is critical to keep the following points in mind before coming up with a revenue-sharing agreement.
What to expect from a revenue-sharing deal
Your expectation from a potential revenue-sharing deal is simple—everybody earns more when there is higher productivity generating sustainable revenue. Likewise, the more effort your partner puts into building your business, the more income you receive.
Revenue-sharing partners offering skills and expertise look for two main things in a revenue-sharing deal:
- That it leverages their asset
- That each contract synchronizes with their other deals
The first strengthens the deal, while the second allows them to build a portfolio by playing different arrangements against each other. As a business, understanding this point of view will enable you to structure attractive and successful revenue-sharing deals.
Additionally, not all revenue-sharing agreements will work. Some will be favorable for you, while others will not. The trick is to set your filters carefully and learn how to structure fair agreements that benefit all parties, and stick to the fine print. It would be best to put in clauses that will motivate the other associated parties to deliver gold.
Finding and evaluating revenue sharing partners
When looking for suitable revenue-sharing partners, you should start by evaluating your operating ecosystem and identifying the competition, marketing influencers, skilled professionals, and other stakeholders.
Suppose you already have professionals offering fee-for-service and you like their work. In that case, you can approach them to become your revenue-sharing partners to increase their performance and buy-in. You can also approach marketing and social media influencers, and bloggers with a significant following among your target demographic.
Once you find potential partners, you need to evaluate if they fit into your business model. But, first, get to know them personally and do your due diligence.
Deciding on the type of partnership
There are three primary revenue-sharing models you can choose from when deciding on the type of partnership you want. These include:
- 50/50 split: Revenue sharing puts all parties on equal footing. However, these partnerships tend to be lopsided and benefit one partner more.
- Royalty: The business pays a percentage of the total amount of revenue to an associated party as royalty based on performance.
- Retainer with Royalty: Here, the business pays an associated party a flat rate fee and royalties.
- Drawing up a revenue-sharing agreement: When drawing up a revenue-sharing agreement, you should agree on a standard reporting method and schedule and a means of verifying the numbers, such as an audit. Additionally, as the responsible party, you need to stick to the agreement for it to work. Appoint a point of contact for all associated parties in your revenue sharing agreement(s) to handle all queries, suggestions, complaints, and follow-up.
In addition, ensure that the revenue split is clear and has no ambiguities. It should also be relatively easy to calculate how much you will pay your partners. Finally, ensure your agreement accounts for different scenarios, such as selling the business, cloning the idea or business, terminating the partnership, handling intellectual property, and handling liability issues.
Why is it important to track revenue sharing?
The revenue-sharing model participants must be clear about how the business collects, measures, and distributes revenue. The events that trigger revenue sharing, for example, online advertisement interaction, ticket sales, or referral business, and their calculation methods are not always visible to all parties involved.
Therefore, the revenue sharing contracts drawn must outline these details, and the parties responsible for the processes commit to audits for accuracy assurance.
The government strictly regulates certain revenue-sharing agreements, for example, those between mutual funds and 401(k) providers.
Revenue sharing FAQs
How does revenue sharing work?
It is the distribution of revenue among the contributors or stakeholders. It is a performance-based model where the revenue distributed is the total amount of income a business generates from product and service fees.
What is the difference between block grants and revenue sharing?
Revenue sharing occurs when governments share part of their tax income with other governments. Its use is not expressly defined by federal or state law or limited to narrowly defined activities. In contrast, block grants from the federal government are for a specific set of programs.
What is an example of revenue sharing?
Revenue sharing (royalty) deals between an individual and a company where the former offer their expertise in return for a percentage of the latter's revenue stream for the said efforts. Depending on the deal agreement, the expert's royalty is either for a business division or its entirety.