Proportional expenses in a family owned business.

Discussion in 'Building Your Business' started by Keith, May 1, 2016.

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  1. Keith

    Keith New Member

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    Hi, my first post on this forum. My sister, brother and I are owners of a family business. My sister owns 45% of the business, my brother and I own 27.5% each. We've inherited our percentages via our parents' will. Initially, parents and sister started the business, hence her larger share of ownership. I'm wondering what are standard business practices regarding the payment of business expenses. In the past, my parents and sister split the profits after all expenses were paid from proceeds. I"m wondering if the expenses, especially taxes, and labor costs should be borne in proportion to the percentage of ownership. As it is now, my brother and I contribute equally on all expenses with my sister, however she gets nearly twice the profit that we do. I realize that there are no rules about this type of arrangement, just wondering if our current approach is common for small business whether family owned or not. Thanks in advance.
    Keith
     
  2. cardine

    cardine Administrator Staff Member

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    Does your company have an operating agreement? If it does then things like this, such as how expenses are paid in or profit is being distributed would be covered in it.

    I am a little confused though by a couple of the expenses mentioned. For expenses, wouldn't the company pay for them? It would make sense to me if the company has labor costs (or any type of expense), that the company pays for it, and then the leftover amount gets distributed based on ownership. Generally you would only be paying for expenses personally if you were capitalizing the company so it wouldn't make a lot of sense for you all to each individually be writing checks for expenses if the company makes enough income to make those payments.

    With that being said this sounds like a complicated enough question that you should absolutely discuss this with a small business attorney. Assuming you are talking about expenses in the thousands of dollars, this is one of those types of events where an ounce of prevention is worth a pound of cure.
     
  3. Bender Bending Rodríguez

    Bender Bending Rodríguez Senior Member

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    What type of entity is the company? Partnership? LLC? C-Corp? something else?
     
  4. Keith

    Keith New Member

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    Its a small family business and partnership. We have no operating agreement. We've just inherited the business from our parents. The company does pay expenses, but as I see it, since the expenses are paid out of the profits (before any distribution to the partners), my brother and my share of the profits would be greater if we split up the major expenses, like property taxes, based on our ownership percentage. Its the ownership percentage that dictates our profits, should it also dictate who pays for the expenses??? So if my sister payed 47 % of the expenses, now there would be more profit left over for me and my brother. Its probably not a huge amount, just trying to have it be a fair process.
     
  5. cardine

    cardine Administrator Staff Member

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    By definition expenses can't be paid out of the profits, since your profit is the amount of revenue after expenses.

    So your expenses are paid out of your companies revenue, and whatever is leftover is profit that gets to be split between you and your siblings. So if I am understanding this correctly, your sister is already paying disproportionately for expenses.

    Think of it this way:

    If you have $10,000 revenue and $0 of expenses, that leaves you with $10,000 of profit. Your sister would get $4,700 and you and your brother would each get $2,750.

    However if you had $10,000, and $2,000 of expenses, you would only have $8,000 of profit. Your sister would get $3,760, and you and your brother would get $2,200 each.

    So that means your sister lost $940 in profit while you and your brother lost $550 each. So your sister "lost" 47% of her profit while you each only lost 27.5%. So by having the company pay all of the expenses, she is paying for more of it than you would be since she is losing out on more profit than you are.

    Now if the company is not paying for it, than it would be a whole different story, but as long as the company is paying for all of the expenses, she is effectively paying for 47% of it herself.
     
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  6. Keith

    Keith New Member

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    I think I see your point. But of the 2,000 in expenses, we are each paying $666. if the profit after expenses is proportionate to ownership, and expenses were figured using the same proportions, my share of the $2000 would be $560??? What am I missing with this logic??
     
  7. Trevor

    Trevor Member

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    If the expenses aren't being paid by the company (and can't really figure out why they wouldn't be as you say it's making a profit) then it would make sense for you to each contribute to expenses in the same proportion as you get the profit distribution.

    I'd suggest getting a lawyer to draw up a simple partnership agreement that you all then abide by if you can't agree by handshake (a piece of paper helps if the situation doesn't stay rosy at some time in the future)
     
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  8. Keith

    Keith New Member

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    Ok, so if it were not a company, and each of us was just a percentage owner of the property, than dividing up expenses and profits proportionally is appropriate. But since its a company, the company pays the expenses before the profit??
     
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  9. Trevor

    Trevor Member

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    Normally, yes, the company pays the expenses and anything that's left after those is profit.

    There's likely tax on the profit as well but that will depend on where the company is located, how much profit made and how good your accountants are :)
     
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  10. cardine

    cardine Administrator Staff Member

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    Yes, that is how it would normally be done.
     
  11. Bender Bending Rodríguez

    Bender Bending Rodríguez Senior Member

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    DUDE. You, your brother, and your sister needs to take a small business class. Your false understanding of basic bookkeeping and accounting is shocking. Learn business before you three ruin the family business.
     
  12. Keith

    Keith New Member

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    I"m the one who doesn't get the bookkeeping stuff, they are pretty good with it. Family business has been successful for 30 years, no complaints. Thanks to all for the comments and suggestions, much appreciated!!