Money

How to Institute a Profit-Sharing Program

How to Institute a Profit-Sharing Program
Image credit: illustration © Paul Wearing
This story appears in the December 2014 issue of Entrepreneur. Subscribe »
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You’d think such a gesture of goodwill would be easy to implement and would inspire greatness from your staff. But in my experience, profit-sharing can be a tricky piece of business that requires caution—and a seemingly never-ending list of questions to answer, ranging from what, exactly, you are rewarding (net profit, overall customer service, quality?) to whom you should include (everyone, or just the team that earned it?). Here are the main points to consider.

How much

Start by allocating to the staff 25 percent of profit (the amount that is typically used), assuming you can afford it. Make sure you are left with sufficient capital to run the business and that your investors, if you have any, will be adequately compensated.

From there, determine whether 25 percent dispersed among the staff is a large enough amount to incentivize them to work harder, or so large that it motivates them to put profit ahead of long-term goals. Adjust accordingly.

When

Distribute bonuses on a quarterly basis. Waiting until the end of the year might not connect the rewards closely enough to work done months earlier, while distribution on a monthly basis can be a burden to administer. Quarterly is just right.

Under the best plans, if there are no profits, there is no profit-sharing, and the loss is carried forward to the next period. But be mindful of carrying forward losses year after year: No employee will be inclined to work for a bonus if they’re still digging out of a hole created 12 months ago. Better to start from zero each year.

Who

I recommend that you exclude yourself from profit-sharing, since you can adjust your compensation through your salary and ownership returns. This will both increase the amount of money you can allocate and build goodwill. 

Now, decide if everyone, or just a select group—usually the team or department that played an outsize role in those profits—gets the bonus. Things will be easier and more transparent if you make the payouts equal within each pool of employees, such as executives, managers, salaried staff and hourly workers. This eliminates privacy issues and incentivizes teamwork. 

Be aware that even with the best intentions, someone will have hurt feelings over how your program gets implemented. Some individuals may resent seeing money they think should have gone toward raises go into profit-sharing instead. I’ve heard of a small company that missed its profit-sharing trigger by just a few thousand dollars due to an employee who was stealing merchandise; as a result, the company didn’t give out bonuses and ended up with a very bitter staff. I’ve worked with a company that had such a convoluted profit-sharing system that neither the employees nor their managers understood how it worked, and most everyone felt ripped off.

Yes, it’s complicated, and you need counsel. Get the input of your trusted executives and even your junior staff. If you belong to an executive peer group, bring it up with them.

Handled correctly, a profit-sharing plan can be a dynamic and effective engine to energize your employees and improve the bottom line. 

Edition: December 2016

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