FAQ 14 What is a fair split for a JV deal
This is a burning question with no definite answer only some compelling guidance rules on how to arrive at a fair conclusion.
Before elaborating we would like to give some background thoughts.
Every project being undertaken be it JV or otherwise brings together various components which combine to complement each other and ultimately complete it successfully.
What are these components? Broadly they are:
Funds: Either by way of borrowing capacity or available equity
Time: Available time to monitor and manage the project during its progression to completion.\Skills: The education and skills needed to manage the process either directly or through delegation.
When undertaking any joint venture, it is always necessary to identify which of the above that you are contributing. A question that is good to ask of oneself is “What do I uniquely bring to the joint venture ie. Something which few others can bring”
If the answer is nothing then look seriously at yourself. Try to address shortcomings so that you can honestly answer that you do bring something into the melting pot.
We often see members looking for joint venture partners that lack education, skills and funds. Their contribution being time alone.
When considering profit splits, we must also consider negative profit split (loss). The spilt chosen represents not only positive profit but also a negative loss. A loss represents a risk. Both partners by definition of profit share also share risk. If a deal suffers a $50k loss then with a 50/50 split they also share 50% of the loss – even if one of the partners is a non-money partner. If the non-money partner does not wish to expose him/herself to as much risk then the choice is
- a) To choose a different split Ratio
- b) To choose a fixed amount instead of a split.
The way to explain how to arrive at a fair spilt is best done by use of an example. Note that these are random figures and nothing should be read into these as benchmarks, rather they are provided for illustration purposes only.
Here are the elements of the JV
THE PARTNERS
Partner A (Money Partner)
Provides funds and borrowing capacity only
Partner B (Non money Partner)
Provides labour and skills
THE PROJECT
An equity producing deal with a sale as the EXIT
All profit sharing to be done on completion of the sale
THE SHARE ARRANGEMENT
The proposal is to share the profits/loss at a defined ratio
It is agreed that the value that Partner B brings (AV) to the JV is $30k
EXAMPLE
Now looking at some example numbers for a profitmaking activity
Total costs (TC) for the project including ALL expenses (but not the value of the labour and skills provided by Partner B are $750k
Example of expenses being various authority fees, bank charges, interest on loans, materials, electricity, gas, water, rates, insurance, Strata fees, sinking fund fees. A variable charge for the use of personal Cash funds In the form of notional interest may also be added if agreed
Total Sales Proceeds (TSP) for the project (but not including selling costs, legal charges, taxes which are to be included in the TC expenses) are $1,100,000
The Gross Profit is TSP minus TC which is equal to $350k
The Net Profit figure is The Gross Profit Figure minus AV value – $350k minus $30K = $320k
With a 50/50 split
Partner A gets $160k (all expenses have been met before profit share)
Partner B get $190k (his $30k service value plus his share)
With a 70/30 split
Partner A gets $224k (all expenses have been met before profit share
Partner B get $126k (his $30k service value plus his share)
Now what happens if the project makes a loss?
Total costs (TC) for the project including ALL expenses (but not the value of the labour and skills provided by Partner B are $750k
Example of expenses being various authority fees, bank charges, interest on loans, materials, electricity, gas, water, rates, insurance, Strata fees, sinking fund fees. A variable charge for the use of personal Cash funds In the form of notional interest may also be added if agreed
Total Sales Proceeds (TSP) for the project (but not including selling costs, legal charges, taxes which are to be included in the TC expenses) are $720k
The Gross Loss is TSP minus TC which is equal to -$30k
The Net Profit figure is The Gross Profit Figure minus AV value – $30k minus $30K = -$60k
With a 50/50 split
Partner A owes $30k (all expenses have been met before loss share)
Partner B is paid $0k ($30k loss plu the cost of his $30k service effectively)
With a 70/30 split
Partner A owes $42k (all expenses have been met before profit share
Partner B is paid $12k ($18k loss plus $30k for services)
What is fair is what is agreeable to all parties and this will be arrived at by negotiation.
What we are suggesting is to have a method of assessing how to arrive at a fair split. This will only happen by talking with the JV partner/s and reaching agreement. It does not matter what anyone else considers fair.
JV’s can be great when funds are short or borrowing is not possible to be able to start out on your own. They also allow the parties to enter into larger deals than any one individual would be able to do alone.
50% of something is always better than 100% of nothing!
Whatever agreement is arrived at, it should be prepared formally by a lawyer, signed and witnessed. There is no such thing as a standard JV agreement – the agreement has to reflect the project and the specific partner requirements.
Ultimate Coaches
The information supplied is general only and not intended to replace professional advice.
