Revenue Sharing

Revenue sharing is a distribution model used by organizations. Firms distribute their revenue among stakeholders and shareholders. To appreciate their employees, some firms distribute revenue through employee bonuses.

Primarily revenue distribution is a firm sharing its success with everyone—especially stakeholders. It ensures continuous support and builds a long-term relationship between the firm and its stakeholders. Governments also distribute revenue; it goes hand in hand with the decentralization of power. Hence, it is often referred to as federal revenue sharing.

• Revenue sharing is the distribution of a company's revenue among stakeholders, shareholders, and other contributors.
• In large corporations, revenue distribution is not limited to stakeholders. Employees and third-party contributors are also rewarded through bonuses and commissions.
• Usually, revenue distribution ranges between 2% and 9%, depending on the firm’s size and total revenue.
• In revenue sharing, the firm distributes revenue and losses to the stakeholders. In the profit-sharing model, firms only share profits; they do not distribute losses.

Revenue sharing is the distribution of a company's revenue among stakeholders and shareholders. For example, some companies share their revenue with employees and distributors through bonuses and commissions.

But not all companies distribute their revenue. When a company distributes revenue, it makes stakeholders happy and earns goodwill in the market. It can even attract future investors. In a way, revenue distribution strengthens the long-term relationship between the firm and shareholders.

Some companies mention revenue distribution upfront in the revenue sharing agreement. In such scenarios, revenue distribution becomes mandatory for the firm. Any detail that is mentioned in a formal agreement becomes legally binding.

Every firm follows a different revenue distribution model—they keep a portion of revenue and distribute the remainder between shareholders, investors, employees, and even third-party distributors.

It is important to note in the revenue sharing agreement that a total revenue share includes manufacturing costs and marketing expenses. It has direct costs but skips indirect costs. Thus, the entire production cost is deducted from the total revenue before it is distributed. Revenue distribution is expressed in the form of percentages.

It is important for all participants in the revenue sharing model to have proper understanding about how the revenue between each of them will be shared and distributed so as to maintain transparency and accuracy.

There are many instances where the revenue generation process may not be visible or identifiable by all parties but can be accessed by only some. In those cases, auditing and maintaining proper accounting details help in clear communication and also avoids legal issues. It gives an assurance to all parties that the process being followed for sharing the earnings are authentic and accurate.

Sometimes some government agencies within a jurisdiction maintain strict vigilance on revenue sharing contract and regulate this process by following certain rules and regulations framed by the government. Thus, it is equally important for parties to be aware of such rules followed in the areas and be updated about any changes taking place regarding the same.

Let us look at some revenue sharing model examples to understand it better.

Example #1

Let us assume that Nathaniel opens a battery manufacturing company. Primarily, the company has investors. So, naturally, the three investors are also stakeholders.

In the first year, Nathaniel generates $900,000 in revenues. He is willing to share some of it with the stakeholders. Nathaniel decides to distribute 9% of revenue—this 9% is equally divided among the three stakeholders. 9% of $900,000 is $81000, so each stakeholder receives $27000.

Further, Nathaniel decides to reward his employees. He distributes 4% of the firm’s actual revenue through employee bonuses. The firm comprises eight employees. Therefore each employee gets 0.5% of firm revenue—4% of $900,000 equals $36000—and receives a bonus of $4500.

In addition, as per the revenue sharing contract, Nathaniel offers 5% to the 20 distributors—5% of $900,000 equals $45000, and is further divided among his 20 distributors—each distributor gets $2250.

After offering 9% to stakeholders, 4% to employees, and 5% to distributors, he is left with 72% of his revenue—$648000. Nathaniel can use the remainder for business expansion, ramping-up, or capital assets.

Example #2

Some sports leagues distribute a portion of generated revenue among players. That is incoming cash flow from ticket sales, merchandise, etc. For example, in the United States, the league shares 48%  of actual revenue with NFL players. Similarly, NBA players earn at least 49% of basketball-related income (BRI).

Now, let us look at some revenue-sharing pros and cons.

First, the advantages:

• Revenue distribution improves long-term relationships between the firm and its stakeholders. This is also applicable to employees who receive bonuses.
• Revenue distribution opens the gates for future funding and investment.
• Revenue distribution attracts new investors.

The  disadvantages of federal revenue sharing are as follows:

• If a firm gets obsessed with figures and revenue, it loses long-term focus. Instead, a business must focus on operations, expansion, innovation, processes, and efficiency.
• From an accounting perspective, revenue distribution is a tedious process—it consumes too much time, effort, and person-hours. This is not to mention the potential errors.
• Excessive emphasis on federal revenue sharing creates excited employees. But unfortunately, out of enthusiasm, employees can compromise compliance.

Now, let us looks at revenue sharing vs profit sharing vs equity comparisons to distinguish between them.

• The firm distributes revenue and losses (with stakeholders) in revenue sharing. In the profit-sharing model, firms share profits but do not distribute losses. On the other hand, equity is a business's net worth. It signifies an investor’s ownership.
• In revenue distribution, stakeholders and equity holders possess voting rights. That is not the case with profit sharing.
• In revenue distribution, revenue is distributed once a year. Profit sharing varies; firms can choose between different payment schedules. Equity holders receive dividends (periodic repayments).
• Compared to equity, a higher percentage is distributed in profit-sharing and revenue distribution models.
• The number of stakeholders and employees is fewer. In contrast, a public company can have thousands of equity holders.

This article has been a guide to what is Revenue Sharing. We explain with examples, differences with profit sharing and equity, accounting arrangement & advantages. You can learn more about it from the following articles -

• Escrow Account
• Bullwhip Effect
• Startup Company