If a firm is used to doing business alone, entering a partnership for the first time can be a confusing undertaking. Day-to-day procedures and habitual business matters often change, and everyone from accounting to project management has to ask new questions during the course of daily work.

Recently, Yusuf Salwati of Houston, wrote to TechRepublic seeking some advice for his firm’s own partnership dilemma. Although the details of the agreement are not final, Salwati’s firm will be handling the IT work while its international partner will conduct all marketing activity once the venture is launched. The partner has asked for some initial marketing help from Salwati’s team because they are new to the IT industry. Salwati’s problem: How does his firm allocate costs and profit between the partners? This article outlines advice Salwati received from another TechRepublic member.

The problem—in-depth
Salwati’s firm—an IT solutions provider—is close to signing a joint venture agreement with a newly formed company within “a very good, established communications company.” Salwati claims that the partner has a great client base and wants the new subcompany to become an IT solutions provider.

“But, the newly formed company needs the help of our company in marketing itself as solution provider,” writes Salwati, “and we may end up placing one or two guys at their site to help with marketing and research.”

With some of Salwati’s staff on board with the preparations, he is unsure how to distribute the cost involved. Also, when the project gets underway and generates income, what’s the most equitable allocation of profits?

Loaded labor rates and returns
According to James Linn of Mississauga, Ontario, the most logical step in allocating cost and profit depends on the actual pricing model for potential customers. If the venture will charge a single price for a “defined set of work,” then the solution is relatively simple: Both sides should agree on a fair percentage split.

But, because there’s a lot of preliminary work involving some of Salwati’s staff, there are some sunken labor costs that may not be offset when income is eventually generated. With sunk costs in mind, Linn recommends considering a loaded labor rate cost model (salary + benefits + overhead costs + profit margin) expanded into enterprise-wide costs.

“I suggest you look at it like we would a computer program to be written. Define the inputs (investment dollars, resources, people) and the outputs (income dollars, customers) and try to align the two,” Linn suggested.

The key, then, is to fully understand the costs that each side is investing in the project from day one and then adjust profit allocation to match the invested dollars or resources. If, for instance, the partner in Salwati’s case injected 35 percent of the costs into the venture but expected only a 25 percent cut of the profit, Linn believes that Salwati’s side would need to offer some kind of “balancing or compensating factor” to make the deal equitable for their 75 percent profit share.

“You can either pay a proportion of the marketing costs or balance that with one of your cost items,” Linn wrote.

If the hypothetical percentages that Linn mentioned held true, Salwati’s firm could allow the up-front costs of sending the one or two staff members to help with marketing and research to make up for the difference in the partner’s initial investment and return.

But, as Linn mentions, no matter how he breaks down costs and returns, Salwati is in for a challenge.

“This [process] is hard because you will be balancing resources (facilities, computers, infrastructure) with human resources and dollars.”

How would you allocate costs?

Do you agree with the methods cited here? Are there alternative ways to allocate costs and profits equitably? Start a discussion and share your thoughts.