What is Net Profits Interest?
Net profits interest is the proportion of net profits paid out to a particular investor, according to his or her percentage stake in the company.
How Does Net Profits Interest Work?
Net profits interest is most often used in reference to oil and gas contracts in which the property owners lease the property to a developer or producer in return for a percentage of the proceeds.
Let's say that John owns an oil field and wants to lease it to Company ABC, which will then get the oil out. Company ABC agrees to the deal and grants John a 20% net profits interest. If Company ABC makes $20,000,000 next year after all expenses are deducted (that is, in net profit), then John is entitled to 20% of those profits, or $4,000,000.
It's important to note that net profits interest is not the same as a royalty interest. (Royalties are paid as a percentage of gross revenues rather than profits).
Why Does Net Profits Interest Matter?
Often, the holder of net profits interest has limited liability in the sense that he or she does not bear responsibility for a sharing a proportionate share of losses (though the owner may deduct the losses from future payments). Typically, net profits interests are considered nonoperating interests for accounting purposes.
It is important that parties to a net profits interest agreement clearly stipulate what expenses and revenues are allowable in the net profit calculation so that the numbers are transparent.