If there’s one thing owners, employees and contractors agree on, it’s that it is always nice to have some skin in the game, especially when business is thriving. A successful profit-sharing program inspires and motivates your employees. It allows you, as the owner, to give back to your team. It even makes for a great story when an employee experiences a windfall.
But for a small business owner, setting up a simple and effective profit-sharing system is a daunting challenge. I know, because I spent the last year building mine.
In today’s article, I’ll show you how to go beyond the common (but misleading) examples of public and venture-backed companies and set up a simple, easy-to-manage, easy-to-understand profit sharing system that will make you and your team members proud.
What the big companies do
Starbucks has granted stock to its employees since the early ’90s, making its Bean Stock program famous for its generosity and for the windfalls many early employees received when the company went public. Amazon granted its warehouse employees stock as part of their compensation until 2018, when it replaced the program with a cash raise.
Back in the 1950s, Sears was the gold-standard of profit-sharing — it invested 10 percent of its earnings in the employee retirement program, allowing longtime employees to retire as millionaires, adjusted to today’s dollars. By one calculation, “if Amazon’s 575,000 total employees owned the same proportion of their employer’s stock as the Sears workers did in the 1950s, they would each own shares worth $381,000.”
And, of course, stock options and equity are the main vehicle by which early-stage software developers and venture capitalists roll the dice in Silicon Valley.
What’s missing from this picture, however, is a clear and simple way for today’s small businesses to share their success with their team. A profit-sharing program is not only a complement to equal pay, diversity and inclusion efforts, it’s also a surefire way to build a strong, stable and dedicated team.
My profit-sharing program provides my 10 team members with a simple, transparent, public formula by which they receive a portion of every dollar the company earns — instantly transforming them from “workers” into “investors,” ensuring they always benefit alongside me (the owner) and our clients and customers.
The profit-sharing program is an important part of achieving my broader goal — which is to build the kind of company I’d want to work for, regardless of where I was in the hierarchy. It’s easy to build systems that benefit the CEO. It’s much more challenging to build equitable, inclusive systems that compensate everyone fairly from the day they start with your company to the day they retire. Combined with our equal-pay policies, the profit-sharing program is a huge step toward achieving that goal.
Keep it simple with cash
As I was describing all those huge companies and their elaborate stock plans, did you feel a little bit out of your league? That’s fine — you can forget about them. While Sears and Starbucks are similar in concept to where we’re headed, we’ll be implementing a much simpler version of this idea that makes it accessible to all small businesses and all teams.
We’ll deal entirely in cash, rather than stock. If you’re not planning to take your small company public or sell it at a 10x multiple someday, thinking about stock ownership just gives everyone anxiety without providing much upside to your team. I know a lot of small business owners who granted their team equity and now regret it, or who never created a profit-sharing system (and thus missed out on the benefits) because they were too worried about dividing up ownership of their company.
Stock is confusing on the employee side, too. For every positive review of the Starbucks and Amazon programs, there are pages and pages of explainers trying to help employees use their newly acquired financial instruments correctly. This is especially tragic when a longtime employee has most of their net worth in company stock and the company’s value suddenly tanks. Because they didn’t have the means or knowledge to diversify, they were unnecessarily tethered to their company and retroactively lost some of their compensation. Employees should not need to hire a financial advisor to benefit from your benefits.
Instead, we’ll build our profit-sharing plan in terms of pure cash payments. At my company, we distribute these payments based on a fixed formula every six months (in April and October). The formula combines the following three factors:
- How long you’ve worked with us (calculated in a spreadsheet as “days since your start date”)
- Your current pay rate (for us, a simple hourly rate)
- How many hours you’ve billed in the past six months
You could use just one or two of these, or add more of your own. For us, they cover the three major variables we want to influence each team member’s share of the profits — your longevity, your role, and, since all of our team members work flexible hours and total hours per week vary from team member to team member, the total hours you’ve billed recently.
There’s no need to get fancy. Make your formula public, simple and fair, and don’t fuss too much about stock, taxes and financial complexity. Just give people money.
Find your financial comfort zone
If you’re new to profit-sharing, my recommendation is to start small and work your way up to bigger and more consistent numbers as time goes on. At my company, I started with a flat $15,000 bonus pool shared among 10 people, with different payments to each person based on the formula I described above.
This wasn’t based on a specific percentage of our profit or revenue, it was simply the number I felt comfortable with at that moment. In a few months, I’ll be making my second payment to the team, and after that I’ll start to work on an exact formula that’s based on either our revenue or our profit over the most recent six-month period. (I prefer revenue because it’s very easy for me to see that number quickly at any moment, whereas profit calculations are delayed a month or two while the bookkeepers work their magic. Since our profit margin is very consistent over time, the two approaches are interchangeable for me.)
Notice that I’m not committing off-the-bat to something like a 5-percent or 10-percent share — because I’m not yet sure what will be feasible and fair. Instead, I’m starting with flat numbers (which are at my discretion), and simultaneously opening my books to my team so they can see the real numbers and understand my reasoning.
I encourage you to dive in while setting appropriate expectations — including that you don’t know exactly what to expect yet. You can present your profit-sharing system to your team as something that will always be there, but that is simultaneously experimental and subject to change in its details. Assuming you have your team’s trust (which your equal pay and open book systems will help with), you’ll be able to give them immediate benefits, and they’ll be able to devote themselves more intensely to your company’s growth, even without having all the details perfectly figured out.
No carrots, no sticks
One of the major distinctions of my profit-sharing system from others is that it is explicitly not a system of performance bonuses. Everyone gets their profit-share, whether they’re the top performer or worst performer on the team. Working in tandem with our equal-pay system, this has two major effects.
First, it encourages cooperation and discourages competition among team members. We don’t want to build a cut-throat environment, we want to build one where everyone has a clear incentive to help and care for everyone around them.
Second, it strongly encourages me and my management team to train our entry-level team members like crazy. When we hire someone new, we know we need to train them up to a level of quality and efficiency that ensures they’re not performing significantly below their peers — because we have voluntarily given up the ability to modify compensation based on subjective measurements like “performance reviews” or perceived skill. Instead, we have created a system that forces us to assume that everyone we hire in the same role is of roughly equal potential, and it becomes our job to help them reach that potential. Needless to say, there are some team members with whom this doesn’t work out and we part ways, but equal pay and equal profit-sharing force us to take training extremely seriously and bring everyone up to their maximum potential as soon as possible.
What we don’t do is set arbitrary goals or reward or punish people based on “production” metrics. In part, this is because these types of performance bonuses are easily gamed and thus often create perverse incentives, like doctors who refuse to take on difficult surgeries so they don’t mess up their success rates, or bank employees who open fake accounts to hit quotas. However, even beyond those counterproductive outcomes, a culture of competition is poison for most teams. Maybe there are some people out there who idealize the Boiler Room lifestyle, but my team and I want to escape the rat race, not build a new one out of arbitrary bonuses and unnecessary competition.
Profit-sharing is about building a system where everyone benefits from every dollar the company earns, and thus encourages everyone on your team (including you!) to adopt a healthy, cooperative mindset at work. When everyone wins and the earnings are shared in a fair, transparent way, you empower your whole team to take your company to new heights.