Peer-to-Peer: What's the best way to create a profit-sharing plan?

Written by ProfitGuide Staff


“We’re a growing company looking to introduce profit-sharing. How do we go about building the best plan? How should it be structured?”

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Reader responses

Michael Scott, Marketing Manager, BBTollFree.com, BBTourguide.com>

Having been on both the designing side and the receiving end of numerous profit-sharing plans over a number of years at several different companies, I believe my comments below reflect a good level of ‘balanced perspective’. (Also, I’m a marketing guy, and my spouse is a career HR executive, so I consider my opinions on this topic to have a ‘best of both worlds-liness’ about them.)

There are as many different ways to ‘structure’ a profit-sharing plan as there are companies. If any three of your executives sit in a room and bat the topic around for a couple of hours, you’ll come up with some great ideas. Here’s a list you can distribute to the participants the day before you get into the room.

I’ll give these to you in bullet form, with just a little food for thought attached, so as not to cramp your imagination. Only YOU know what’s best for YOUR COMPANY.

  • I didn’t assume that you meant “shares of the company” when you said “profit sharing”; neither should you. A piece of the rock may be attractive to some folks. Others are happier with cash. (Think Enron!)
  • Let everyone in the company participate. No one wants to think that they didn’t contribute to growth. The warehouse, credit clerk and the caretaker, everyone who’s an employee can play a role in helping a young company take great strides. Yes, you sales types: “nothing happens till something gets sold …”, but nothing else happens till it’s shipped AND paid for.
  • Tie the reward to a S.M.A.R.T. performance management or goal-setting initiative. (you know, Specific, Measurable, Attainable, Relevant and Timely). There has to be a dollar figure attached to the program, whether it’s finite or variable, shares, cash, vacuum cleaners or trips to Hawaii, so it’s only natural that it’s going to become a part of your overall payroll budget. (Note of caution: don’t make any reward program totally open-ended; you may inadvertently end up with too many millionaires and not enough employees.)
  • Give the program a simple, lovable name so that your staff can talk about it in the cafeteria and get excited about it. If you have a company mascot, tie it in with him/her/it. Make it ‘part of the corporate family’. After all, if they treat this baby with love, respect, hard work and good ideas, it’s going to reward them like a little personal pot at the end of the rainbow.
  • Without sounding negative, link the scope of the funding firmly to the bottom line, and have monthly financial meetings in the lunchroom (by conference call, or whatever works, based on your size and spread) where you lay out and play out the achievement-to-target-to-date. Build one of those thermometers to show how far you’ve gone and how far to go. Yes, it’s hokey, but it works!
  • Let the lawyer and the accountant pitch in. Like it or not, what you’re considering is called Variable Compensation. Make sure your accountant, payroll department, HR person … whoever looks after “PAY”, is fully versed by Canada Customs and Revenue as to the tax impact of this element of the payroll. You’ll want to make sure what you’re doing is legal, too.
  • Confidence and integrity are paramount in any situation where your staff’s income is involved. Much as I hate to use the dreaded word “committee”, you’ll need a respected team of senior managers who are clearly identified as the ‘authors’ of the program.
  • Speaking of team, if it makes sense (and doesn’t get too unwieldy) think about creating the program in such a way that it encourages teamwork: amongst departmental associates, between divisions, across national borders … everywhere you can breed cooperation, rather than the sometimes dangerously counterproductive ‘competition’.

Don’t be afraid to ‘massage’ your program as needs change over the years. Invite input from all participants. Keep it simple. Have fun. Be able to prove (to yourselves and all stockholders) that it worked.

Mike Salveta, Managing Director, HROI

The question you ask is very complex and I would need to know more about your business type and business orientation (Are you focussed on product excellence, operational efficiency or customer intimacy?), the business definition and whether the business is private or discloses financial information. However in principal the following bullets would be some valuable points to consider:

  • First ask youself why you think you need profit sharing. What do you expect to achieve by profit sharing? How does this tie link with your business plan to drive revenue or reduce expenses.
  • Second, make sure you really understand the pro’s and con’s of profit sharing vs. a performance-based bonus system. Once you have determined profit sharing is the way to go, here are some basic guidelines:
    • Identify which “profit” you will share. Depending on your business and the cost structure, net profit before or after tax and depreciation may be more appropriate.
    • Identify how much of the profit will be shared. Will it be a percentage, flat amount or rolling average (to take into account seasonality and years where losses occur)?
    • Identify who is entitled to share in the pool. (You may want to structure it based on different factors, i.e. once 5 years of service is reached or using service plus a minimum attained performance rating.)
    • Identify the formula to share the pool with the eligible participants. This is wide open but my general rule of thumb recommendation should be geared to the best long term interests of the Company and be tied to performance. However, many Companies take the approach of splitting it evenly either as a percentage or flat $ amount.

A work of caution. Profit sharing in a private company could be a demotivator depending on what is actually shared and what employee perceptions of are about how revenue and spending were managed during the year by Management.

Alternatively, an incentive program based on business measurements and factors that the employee can more directly see and influence may be more beneficial. Don’t implement a profit sharing program because of the wrong reasons.

Sherri Burch-Lewis, Robert J. Green & Associates

As a group benefits consultant, you should consider a structured deferred profit sharing plan (DPSP) so your employees know you are committed to the endeavor. As well, if it is registered with CCRA, there are deductions for the contributions, and the contributions are not subject to payroll taxes, (ie. CPP, EI, EHT and WSIB, if applicable). You can also have a vesting period, if you choose, so if employees leave your organization within 2 years of plan membership, the contributions come back to you as the employer. If this is not your wish, you can have immediate vesting, where if the employee terminates, they then have access to this contribution.

All the best in proceeding with this!

Marco Nardone, President, EAI Energy Alternatives Inc.

Based on my experience as an owner / operator of a growing consulting engineering firm, I have found that a successful profit sharing or reward system should built on a few simple fundamentals:

  • Take the time to develop a performance monitoring system based on setting goals and reviewing each individual’s success in achieving their goals. Each person’s goals should be developed through an open discussion between the relevant management and the person. Setting goals that both parties agree on can be a very good motivational tool. Set timelines together and monitor performance with respect to the mutually agreed upon goals and timelines. The specific goals should be based on whatever it is that makes your company succeed but also consider each person’s career development.
  • Now that you understand how each individual contributes to the bottom line, you have a measure of how he or she should share in the reward (the Profit!).
  • Communicate how the company is doing financially. If people understand the reward system and how their efforts contribute to the growth and future of the company, they will appreciate knowing how the company is doing — whether it’s good news or bad news, they will be motivated to push ahead.
  • Don’t get too caught up in the individual. Reward systems should encourage the growth and contribution of the team. Otherwise, you might create an adversarial environment where one person can hinder another person’s progress just to get a bigger share of the pie. Be sure to communicate that the best possible scenario is one where everyone is achieving their goals.
  • Award seniority, loyalty and exemplary performance.
  • Apply these fundamentals to develop a system to calculate rewards / profit sharing. Keep it simple. Determine an appropriate percentage of profits to share with the staff (eg. 10% to 20%, or whatever works for your firm) and provide people with a factor of the total based on the above points. You will have a combination of quantitative and qualitative factors for each person based on a achieving goals, seniority, generating revenue … The profit sharing can be given as one lump sum before Christmas or pay out quarterly over the following year.

Include rewards other than just individual monetary rewards. Set goals for groups or departments and provide non-monetary rewards for the group (eg. a subsidized trip, an unscheduled long weekend or an activity that they would like to do together). Have some fun with it and let them suggest group rewards.

A flexible, simple system based on these fundamentals can grow with the company and provide individuals and teams with the motivation to drive the company to greater profits.

Del Reinhart, Hose Headquarters

David Tyson (tyson.consult@sympatico.ca) wrote a book on this subject that is filled with “food for thought” as well as specific ideas. He also happens to be a consultant on compensation.

Good luck.

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Originally appeared on PROFITguide.com