DEFINITION of Net Profits Interest
A net profits interest is an agreement that provides a payout of an operation's net profits to the parties of the agreement. They are common in oil and gas companies. A net profits interest is a non-operating interest that may be created when the owner of a property — typically an offshore oil and gas property — leases it out to another party for development and production. The other party is guaranteed to be paid a portion, or has an interest in, the net profits generated by the operation. A net profits interest may be granted instead of a royalty interest, where the holder receives a share of gross revenues rather than net profits.
BREAKING DOWN Net Profits Interest
The holder of a net profits interest is not liable for paying a proportionate share of losses if the property is unprofitable. However, depending on the stipulations of the lease contract, the working interest owner may recover these losses from future payments of net profit.
Example of a Net Profits Interest
For example, such an interest may be created when Company A, which owns the rights to explore and develop an oil and gas property, leases it to Company B, in exchange for a 12% share in net profits from the leased property. In a given year, if Company B makes $10 million in net profits after deducting all allowable and applicable expenses from revenue generated from the property, $1.2 million would be payable to Company A as its share of net profits.
In order to avoid legal complications down the road, the exact definition of net profits and the expenses that are allowed to be deducted from revenue to arrive at it should be clearly specified in the lease contract. Accounting transparency is another prerequisite.