Kevin Jun Lin, Corporate Lawyer

I. Case Study: A Brotherhood Torn Apart by a Profit-Sharing Dispute

In 2021, Wang, Li, and Zhang, three college classmates, jointly founded a restaurant chain company, “Wei Mei Ge,” holding 50%, 30%, and 20% of the equity respectively. The company grew rapidly after its establishment and achieved a net profit of RMB 5 million in its first year.

When it came time to distribute dividends, Wang (the majority shareholder) argued: “Profits should be split by capital contribution ratio — I get 50%, Li 30%, and Zhang 20%.” Li and Zhang objected: “The three of us contributed equally. Why should he get half? It should be split evenly!”

The articles of association did not specify a profit distribution method and merely stated “to be handled in accordance with the law.” Under Article 210 of the newly revised Company Law, shareholders of a limited liability company receive dividends in proportion to their paid-in capital contributions, unless all shareholders agree otherwise.

As the three could not reach an agreement, the dividend matter was shelved. Subsequently, Li and Zhang joined forces and attempted, through a shareholders’ resolution, to remove Wang as chairman, plunging the company into a governance deadlock. In the end, this “profit-sharing battle” caused the company to miss a prime expansion opportunity, and its valuation shrank significantly.

This case reveals a simple but often-overlooked truth: how to split profits once the money is made must be clearly agreed upon at the very founding of the company, or even “brothers” will turn into enemies.

II. Statutory Interpretation: Profit Distribution Rules under the New Company Law

(1) Article 210 of the New Company Law: Basic Rules on Profit Distribution

Company Law of the People’s Republic of China (2023 Revision), Article 210

When distributing the after-tax profit of the current year, a company shall set aside ten percent of its profit as statutory reserve fund. If the cumulative statutory reserve fund has reached more than fifty percent of the registered capital, no further appropriation is required.

If the statutory reserve fund is insufficient to cover losses from previous years, the company shall first use the current year’s profit to make up such losses before appropriating the statutory reserve fund as prescribed in the preceding paragraph.

After appropriating the statutory reserve fund from after-tax profit, a company may, by shareholders’ resolution, also set aside discretionary reserve fund from after-tax profit.

The remaining after-tax profit after covering losses and appropriating reserve funds shall be distributed by a limited liability company in proportion to the paid-in capital contributions of its shareholders, unless all shareholders agree to distribute otherwise; a company limited by shares shall distribute in proportion to the shares held by its shareholders, unless its articles of association provide for distribution otherwise than by shareholding ratio.

Shares of the company held by the company itself shall not be entitled to profit distribution.

(2) Key Points of the Article

1. Statutory order of appropriation Cover prior-year losses → appropriate statutory reserve fund (10%) → appropriate discretionary reserve fund (optional) → distribute remaining profit.
2. Default distribution rule A limited liability company distributes in proportion to paid-in capital contributions (note: “paid-in,” not “subscribed”).
3. “Agreement prevails” principle All shareholders may agree to distribute otherwise than by capital contribution ratio (e.g., by shareholding ratio, by contribution, or by role value).
4. Specifics of companies limited by shares A company limited by shares distributes in principle by shareholding ratio, but its articles may provide for distribution otherwise than by shareholding ratio (e.g., a dual-class share structure).
   

⚠️ Practical Note:

“Agreement of all shareholders” means unanimous consent of all shareholders, not a majority vote. Therefore, if the articles of association do not specify a special profit distribution method and the shareholders subsequently fail to reach agreement, distribution can only follow the statutory rule (paid-in capital contribution ratio).

(3) Order of Loss Bearing

If the company suffers losses, how are they borne? Under the newly revised Company Law:

1. First cover losses with the current year’s profit
2. If profit is insufficient, cover with reserve funds
3. If still insufficient, shareholders bear the shortfall in proportion to capital contributions (unless all shareholders agree otherwise).

It should be noted that shareholders of a limited liability company are liable to the company only up to the amount of capital they have subscribed. Therefore, if the company is insolvent, shareholders need only bear liability within the scope of their subscribed capital contributions (no further liability for amounts already paid in).

III. Practical Points: How to Design Fair and Reasonable Profit Distribution Clauses? 💡 Practical Guide

Point 1: Specify the distribution method explicitly to avoid the “statutory default rule”

If you do not wish to distribute by “paid-in capital contribution ratio,” you must explicitly specify the distribution method in the articles of association or shareholders’ agreement. Common approaches include:

• Distribution by shareholding ratio The most common and simplest approach;
• Distribution by contribution e.g., the CEO takes 20%, the CTO 20%, and the rest by capital contribution ratio;
• Distribution by role value e.g., full-time founders take more, part-time founders less;
• Tiered distribution e.g., profit up to RMB 1 million is distributed at ratio X, and the portion above RMB 1 million at ratio Y.
  

Point 2: Establish a “differentiated voting and profit rights” distribution mechanism

For founders, it may be necessary to separate “voting rights” from “profit distribution rights.” For example:

A class A shares (held by founders): one share carries 10 voting rights, but profit distribution rights follow the shareholding ratio; Class B shares (held by investors): one share carries one voting right, with profit distribution rights following the shareholding ratio.

This arrangement allows founders to retain control after financing while giving investors a reasonable return on investment.

Point 3: Agree on the timing and minimum of profit distribution

To prevent a majority shareholder from manipulating profit distribution (e.g., “rolling the snowball without paying dividends”), minority shareholders may provide in the articles:

• Minimum profit distribution ratio e.g., “no less than 30% of net profit shall be distributed as dividends each year”;
• Timing of profit distribution e.g., “profit distribution shall be completed within 3 months after the end of each fiscal year”;
• Cap on retained profit e.g., “retained profit shall not exceed 50% of the registered capital, and any excess must be distributed”.

Point 4: Clarify the calculation date for “paid-in capital contribution ratio”

The newly revised Company Law provides distribution by “paid-in capital contribution ratio” but does not specify the calculation date. Is it the date the distribution resolution is adopted or the end of the fiscal year?

It is advisable to provide expressly in the articles: “The profit distribution point in time shall be the date the shareholders adopt the distribution resolution, and the calculation shall be based on each shareholder’s paid-in capital contribution ratio as of that date.”

Point 5: Agree on exceptions to loss bearing

Although the statutory rule is to bear losses by capital contribution ratio, all shareholders may agree to bear losses otherwise than by capital contribution ratio. For example:

“If a loss is caused by a shareholder’s fault, that shareholder shall bear the entire loss”; “The founder undertakes that if the company loses money for three consecutive years, the founder shall make up the investor’s share of the loss with personal assets.”

Such provisions can enhance investor confidence, but care must be taken not to violate the “principle of fairness” under the PRC Civil Code.

IV. Common Profit Distribution Disputes and Resolution Approaches

(1) Dispute 1: The majority shareholder is reluctant to distribute — what can minority shareholders do?

Scenario: The company is profitable year after year, yet the majority shareholder controls the shareholders’ meeting and refuses to adopt a profit distribution resolution, leaving minority shareholders unable to receive dividends.

Resolution:

1. File an action for a shareholders’ resolution based on the articles If the articles stipulate the timing and minimum of profit distribution, minority shareholders may require the company to perform its obligations under the articles;
2. Request the company to repurchase equity under Article 89 of the new Company Law If a company fails to distribute profit to shareholders for five consecutive years while remaining profitable throughout those five years and meeting the conditions for profit distribution under this Law, a shareholder who voted against the relevant shareholders’ resolution may request the company to acquire its equity at a reasonable price;
3. File an action for dissolution: if serious difficulties arise in the company’s operation and management such that its continued existence would cause material loss to shareholders’ interests and cannot be resolved by other means, a shareholder holding more than 10% of the total voting rights may petition the people’s court to dissolve the company.

(2) Dispute 2: The company refuses to implement the profit distribution resolution after it is adopted

Scenario: The shareholders’ meeting has adopted a profit distribution resolution, but the company delays payment of dividends.

Resolution:

1. File an action for shareholders’ profit distribution right Based on Article 210 of the new Company Law and the shareholders’ resolution, demand that the company pay the dividends;
2. Apply for compulsory enforcement If the court rules in favor but the company refuses to comply, apply to the court for compulsory enforcement.
   

(3) Dispute 3: Loss-bearing terms are unclear and shareholders shift blame onto one another

Scenario: The company suffers losses; the articles do not specify how losses are borne, and shareholders dispute “who should bear more.”

Resolution:

1. Apply the statutory rule Bear losses in proportion to paid-in capital contributions;
2. Negotiate a separate agreement All shareholders may negotiate and sign a supplementary agreement specifying the loss-bearing method (requiring unanimous consent of all shareholders).
   

V. Risk Warning: Common Pitfalls in Profit Distribution Clauses ⚠️ Risk Alert

Risk 1: The articles merely state “to be handled in accordance with the law” without specifying a distribution method

This is the most common pitfall. If the articles do not specify, the statutory rule (distribution by paid-in capital contribution ratio) applies, which may not reflect the shareholders’ true intent.

Recommendation: Specify in detail in the articles the distribution method, timing, and minimum, and avoid vague phrases such as “to be handled in accordance with the law.”

Risk 2: A “differentiated voting and profit rights” arrangement is agreed but not registered with the authority

If the articles provide for “differentiated voting and profit rights” (e.g., a dual-class share structure) but it is not filed at the time of registration, the clause may not be asserted against a bona fide third party.

Recommendation: Include the “differentiated voting and profit rights” clause in the articles and file it at the time of registration.

Risk 3: No cap on retained profit, leading to “rolling the snowball without paying dividends”

If the articles do not cap retained profit, a majority shareholder may use the “snowball” approach to devote all profit to company expansion, leaving minority shareholders without dividends.

Recommendation: Provide in the articles: “Retained profit shall not exceed X% of the registered capital, and any excess must be distributed.”

Risk 4: Distributing profit without first appropriating the statutory reserve fund

Under Article 210 of the new Company Law, when distributing the current year’s after-tax profit, a company shall set aside 10% of the profit as statutory reserve fund. Distributing without such appropriation constitutes unlawful distribution, and shareholders must return the distributed profit to the company.

Recommendation: In the profit distribution plan, strictly observe the statutory order of appropriation to avoid unlawful distribution.

Risk 5: A loss-bearing clause stating “the majority shareholder bears all losses” may be deemed invalid

A clause providing that “all losses are borne by the majority shareholder” may be rescinded on the ground of manifest unfairness. Under the PRC Civil Code, a party prejudiced by a manifestly unfair civil juristic act has the right to request its rescission.

Recommendation: Loss-bearing clauses should be fair and reasonable, avoiding one-sided arrangements.

VI. Action Recommendations: Three Steps to Improve the Profit Distribution Mechanism 🎯 Take Action Now

Step 1: Review your articles of association immediately and fill any gaps

If your articles do not specify a profit distribution method or merely state “to be handled in accordance with the law,” it is advisable to convene a shareholders’ meeting promptly to amend the articles and specify the distribution method.

Note that amending the articles requires approval by shareholders representing more than two-thirds of the voting rights (for a limited liability company). If the majority shareholder opposes the amendment, minority shareholders may find it difficult to push it through.

Recommendation: Design the profit distribution clause soundly at the founding of the company to avoid later disputes.

Step 2: Specify the details of profit distribution in the shareholders’ agreement

Because the articles of association must be registered, their content is usually concise. To specify the details of profit distribution (such as timing, minimum, and cap on retained profit), it is advisable to provide for them in the shareholders’ agreement.

Although a shareholders’ agreement need not be registered, it is legally binding on the signing shareholders. In the event of a dispute, it serves as important evidence.

Step 3: Periodically review the profit distribution policy to ensure it matches the company’s development stage

At different development stages, a company’s profit distribution policy should differ:

• Startup stage Profit should be prioritized for company development; one may agree to “no dividends in the first three years”;
• Growth stage Dividends may be paid appropriately, but sufficient funds should be retained to support expansion;
• Mature stage The dividend ratio should be raised to reward shareholders.

Recommendation: Review the profit distribution policy once a year to ensure it matches the company’s development stage.

Special reminder: If you are facing a profit distribution dispute or need to amend the profit distribution clause in your articles, we strongly advise consulting a professional lawyer promptly. Resolving profit distribution disputes often requires deploying multiple legal tools — the Company Law, the PRC Civil Code, the articles of association, and shareholders’ agreements — and the involvement of a professional lawyer is essential.

VII. Conclusion

“How to split the money once it is made” may look like a simple math problem, but is in truth a complex legal and human one.

Countless startups fail not because they cannot make money, but because they cannot or do not divide it well. Brotherhoods turn to enmity, teams fall apart, and companies reach deadlock — often all rooted here.

Therefore, for entrepreneurs, designing sound profit distribution and loss-bearing clauses at the founding of the company is the best way to avoid later disputes. Remember: “Settle the hard terms first, then keep the relationship” — only then can you part gracefully and achieve win-win cooperation.

If you have any questions about designing profit distribution clauses or resolving disputes, please contact the legal team of Lawyer Kevin Jun Lin. We will provide you with a professional profit distribution solution tailored to your company stage, shareholder composition, financing needs, and other factors.

Lawyer Kevin Jun Lin . Company Law Treasure · Focused on Corporate Legal Practice

Disclaimer

This article is for general reference only and does not constitute legal opinion or advice. For specific legal issues, please consult a professional lawyer. The cases in this article are adapted from real events, and the company names and details involved have been anonymized.

Lawyer Kevin Jun Lin

Senior Corporate Lawyer · Industry Legal Practice Expert

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About the Zhenpin Lawyer Team

Lawyer Kevin Jun Lin — Today’s Author

Currently a part-time PhD candidate in Civil and Commercial Law at China University of Political Science and Law. Combining deep theoretical knowledge of company law with extensive practical experience, he focuses on company law, shareholder disputes, corporate compliance systems, data compliance, and product quality disputes.

Lawyer Yan Ge: Founder of the law firm, with decades of frontline legal experience across the courts, supervisory, judicial, and corporate dimensions.

Lawyer Lin Bing: 27 years in practice, with a dual background in law and finance, having handled over 2,000 litigation and non-litigation matters.

Further Reading

• When a Founder Suddenly Dies, Who Gets the Equity? Without This Clause in the Charter, Everything Changes
• Non-Compete Clauses: What Can You Do When a Partner Starts a Rival Business?
• Equity Vesting: What Happens to Equity When a Founder Leaves Early?
• Redemption Rights: What Must Founders Repay When Investors Withdraw?
• Valuation Adjustment Mechanisms (VAM): The Hidden Knife When Investors Hand You Money
• Drag-Along and Tag-Along Rights: What Can Minority Shareholders Do When Majority Shareholders Want to Sell?

If you need professional support in shareholders’ agreements, investment term review, or shareholder disputes, please contact Lawyer Kevin Jun Lin (Shenzhen Corporate Lawyer) for one-on-one consultation.