Revenue sharing
Revenue sharing has historically been discussed in the context of retirement accounts or insurance policies. For small businesses, it is now being discussed as businesses explore ways to improve cash flow. During the 2020 pandemic, businesses are getting very creative with revenue sharing agreements.
Revenue sharing involves sharing operating profits
For example, a business owner may share profits when another business refers new customers. Or, revenue sharing can be used to distribute profits that result from a business alliance.
- Revenue sharing can be flexible in design to share operating profits or losses among associated financial actors.
- Revenue sharing can ensure each entity is compensated for its efforts.
Revenue Sharing Agreements (RSAs)
special section provided by Justin Ritter, Ritter Law PLLC
Rarely used while business valuations were stable pre-pandemic, revenue sharing agreements (“RSA” or “RSAs”) may become the wave of the future for Virginia companies seeking investment, and perhaps are even the wave of the present.
At its core, a RSA is easy to create and simple in concept. In these agreements, a given company seeking investment agrees to (i) share a certain percentage of their revenue with investor(s) until (ii) a certain multiple of their investment is returned to them.
RSAs will continue to rise in popularity primarily because (a), unlike equity deals, RSAs do not deal with business valuation, and (b) RSAs provide management with needed flexibility during uncertain times.
To better appreciate said flexibility, compare RSAs to its cousin, debt. Debt, whether offered by an institutional lender or private investor, invariably requires the debtor to pay back the loan according to a fixed payment or amortization schedule…any missed payment, regardless of general economic conditions (with a few exceptions), generally gives the lender the right to call the loan. Because RSA payment obligations track a percentage of revenue, and not a fixed payment schedule, the payments to the investor are higher during good times and are lower during bad times.
As a second comparison, compare RSAs to traditional equity investments. Once the revenue payment multiple has been paid to the investor, the RSA is satisfied in full and thus terminated. Upon payment completion, no future payments are owed to the investor. With equity investments, the investor effectively dilutes ownership of the company, which necessarily as a result lowers the returns to the other owners of the company should there be a company exit event, such as an asset sale, merger, or equity sale, etc. If paid in full according to commercially reasonable terms, RSAs should always be less dilutive to the founders of a company than traditional equity investments.
RSAs are most ideal for companies with currently existing revenues (or companies that have a high likelihood of creating and scaling revenue quickly). Generally speaking, the higher the risk to the investor, the higher the revenue multiple return should be within a given RSA. RSAs are a fantastic opportunity for companies that need additional investment to scale their operations and have purchase orders (“POs”) in hand. POs typically are not sufficient collateral to receive a loan from an institutional lender, but are highly relevant and compelling for a prospective RSA investor.
Below find a helpful chart that compares the pros and cons of issuing RSAs as compared to issuing equity and debt:
Equity | Debt | RSA | |
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end of special section
Other Revenue Sharing options
When two parties work together to share in financial reward based on operating profits, revenue sharing has occurred. A common example is seen in the growth of online businesses and advertising models. Third party marketplaces (like Amazon and Etsy) take a cost-per-sale revenue share in exchange for access to successful advertising and marketing channels.
The types of profit sharing agreements can be nearly as varied as the number of industries that exist. Key elements are:
- Mutual benefit,
- Clear guidelines of performance
- Financial tracking in sales and contributions
- Clear exit options from the agreement.
Not sure if this strategy is effective for your business? We are happy to explore the financial implications and considerations with you. Here is another example.
Example: Branding and Events
Several major professional sports leagues use revenue sharing with ticket proceeds and merchandising. For example, the separate organizations that run each team in the National Football League (NFL) jointly pool together large portions of their revenues and distribute them among all members.
As of 2020, the NFL and the players’ union agreed to a revenue share split that would pay the team owners 53% of the revenue generated while players would receive 47% as reported by CBS Sports. In 2019, the NFL generated $16 billion in revenue, meaning that slightly more than $8.5 billion was disbursed to the teams while the remaining got paid out to the players.
Various kickers and stipulations can be added to revenue sharing agreements. If the NFL season, for example, got extended from 16 to 17 games in the coming years, the players would receive additional revenue or a kicker if advertising revenue from T.V. contracts increased by 60%. In other words, revenue sharing agreements can include percentage increases or decreases in the future depending on performance or specific pre-set metrics.
Example: Third Party Marketplaces, online business activity
The growth of online businesses and advertising models has led to cost-per-sale revenue sharing, in which any sales generated through an advertisement being fulfilled are shared by the company offering the service and the digital property where the ad appeared. There are also web content creators who are compensated based on the level of traffic generated from their writing or design, a process that is sometimes referred to as revenue sharing.
Tracking Revenue Sharing
Participants in revenue sharing models need to be clear about how revenue is collected, measured, and distributed. The events that trigger revenue sharing, such as a ticket sale or online advertisement interaction and the methods of calculation are not always visible to everyone involved, so contracts often outline these methods in detail. The parties responsible for these processes are sometimes subjected to audits for accuracy assurance.