A profit-sharing plan takes a percentage of your company’s profits and shares it with your team on top of their regular compensation plan. It’s a great way to give your team extra money without creating entitlement because it’s directly tied to their hustle.
Profits happen when revenue goes up and expenses go down. Help your team remember to work like they’re all self-employed. The more they hustle, the bigger the pool of shareable profits will be.
What to Do Before You Start a Profit-Sharing Plan
This may seem obvious, but you’ll be ready to create a profit-sharing plan when your business is making a profit consistently (plus a few other things listed below).
Check these things off your list before you get started:
- Have a working budget. You have to know your numbers to know how much money you can afford to share. When you get your business on a budget (and stick to it), you tell your money where to go instead of wondering where it went. And if you’re not on a budget first, a profit-sharing plan could starve your business of cash and do more harm than help.
Related article: How to Create a Business Budget
- Pay yourself a living wage every month. This is an absolute must. Pay yourself a living wage from your business first, then set up a profit-sharing plan. Period.
- Set aside three to six months of retained earnings. This is your rainy-day fund. Set aside all the money you need to perform your basic operating functions (like making payroll and keeping the lights on) for three to six months. With a buffer like that, if an expensive piece of equipment goes kaput, you won’t have to pull your team’s profit-sharing checks to pay for its replacement.
- Get on a plan to crush your business debt. Debt is a thief. It steals from your future and leaves your business wide open to financial catastrophe. Paying off debt, on the other hand . . . now that’s a smart way to theftproof your business.
- Run the numbers. Finally, take a look at three different scenarios—a month that’s really slim, a month where you make what you expect to make, and a month where you crush and exceed your goals. Would the percentage of profits you choose to share be enough to make an emotional difference in each of those scenarios? In other words, would your team feel the ups and downs? If the amount they’d get in the “crushed it” scenario is still pretty small, you might just treat your team to lunch with that extra money every month instead. Keep building your company culture and growing your profits until you’re ready to roll out a profit-sharing plan that makes a difference in your team member’s lives.
Related article: What Is Company Culture?
Ready to Level Up Your Business?
Find out your Stage of Business with our free assessment and get free resources to help you level up by focusing on the right things at the right time.
How Do You Set Up a Profit-Sharing Plan (and How Does a Profit-Sharing Plan Work)?
Let’s be real. There are some right ways to set up a profit-sharing plan and some incredibly wrong ways. Usually, a bad rollout is tied to poor communication or not knowing what you can afford to share. So, let’s look at how to create a profit-sharing plan that fires up your team:
- Decide on the percentage you’d like to share. The percentage of profits you share is completely up to you. Remember, this is money you’re choosing to share. If you’re paying your team at or above market value (and you should be), then profit sharing is just the icing on the cake.
- Decide who qualifies for profit sharing—and when. Most people who have some level of ambition want to see their wins at work translate to their paycheck. Profit sharing is a great way to motivate the work of administrative and support roles—people who aren’t closing a deal on commission but who probably put in just as much work to get the salesperson and the client at the same table. And you might want to wait until they’ve been on your team for at least a year before they’re eligible. This gives new team members something to look forward to while allowing you to make sure their first year pans out okay (and that they’re a thoroughbred, not a donkey).
- Think through your communication plan. Every profit-sharing check should come with an explanation. This might mean gathering your staff monthly and comparing what your company made that month to what it made in the same month last year. Then, you could talk through factors that may have negatively or positively affected the numbers and end by reminding your team where profits come from. Profits happen when revenue goes up and expenses go down. Care about your work like you’re self-employed! Now there’s a mantra worth promoting! When your staff really understands that earning a profit is a team effort and something their business owner chooses to share, they can keep their eyes on the prize while you get to reward the work you value. Talk about bang for your buck!
Related article: How to Communicate Effectively
A word of caution: Don’t roll out a profit-sharing plan and then decide to change your mind. Really think this through and run the numbers before you start handing out cash.
How Do You Calculate Profit Sharing?
Developing the right formula for your business takes some trial and error. But here’s one method to consider—calculate the percentage each team member gets using three things: the number of years they’ve been with the company (50% of the weight), the profitability of their specific area (17%), and their performance (33%).
Every business goes through five distinct stages. Find out which stage your business is in with our free assessment.
Play around with different percentages and the factors you value (what gets rewarded gets repeated). Remember, it’s okay to make adjustments to get it right.
Here’s something to keep in mind regarding seniority: Usually, the longer a team member has been with a company, the harder they are to replace. That said, you don’t want to keep people who don’t work hard. So, seniority should be less about time spent on the job and more about the level of experience gained over the years.
Pros and Cons of Profit Sharing
Great team members should be rewarded with money. It’s that simple. But you have to set up incentives that bring legitimate payoffs to both your team and your business. Remember, you don’t want your profit-sharing plan to backfire. With that in mind, let’s look at some of the benefits and risks of profit sharing.
Pros of Profit Sharing:
- The greatest benefit of profit sharing is encouraging a self-employed mentality. Sharing company profits the right way motivates your team to work harder and smarter. When team members feel like partners, they act like partners—and carry the vision and outcomes like entrepreneurs and owners who care about their business.
- A profit-sharing plan encourages teamwork. Every area of the business affects profits. When your team really understands this reality really gets this, they’ll make sure their specific area succeeds and then go a step further to help others succeed too. One team, one dream.
- Profit sharing rises and falls with the company’s profitability. Unlike a 401(k) or other benefits plans, a profit-sharing plan is directly impacted by how your business is doing. It’s a powerful motivator and unifier no matter if your business is in a booming season or a slower one. And in those slower seasons, you’re not obligated to pay out a fixed amount until profits return.
- You can change how much you contribute each year based on your business goals. Maybe you need to set more aside to invest into building or upgrading or you want to show your team extra love for work well done. Just raise or lower your contribution to fit the goal.
- Sharing your profits is a great way to say thank you (and a great way to build a more positive culture and boost morale!)
Cons of Profit Sharing:
- Lousy employees would benefit from it. Everyone included in your business’s profit-sharing plan is eligible to benefit from (or miss out on) the same perks together—so hopefully you’re staying on top of your team’s performance. A team member who’s on fire could get frustrated if a coworker with less spark is reaping the same financial rewards as them.
- You have to be open about your business’s finances. If you’re serious about wanting your team to share a self-employed mentality, you have to show them the good, the bad, the ups and the downs. This might not be something you’re comfortable with, but it comes with the territory of sharing the profits.
- Profit sharing can lead to greedy team members. It’s sad but true. If you don’t make the connection between profits and your business’s mission and services clear, anyone on your team could be tempted to make a sale or cut a corner that isn’t actually in the customer’s best interest—just to add to their bottom line. Integrity and purpose are two of profit sharing’s best friends. They help your team members keep the right perspective.
- If done poorly, profit sharing can be taken for granted or seen as a right. That’s why talking about the DNA of your profit-sharing plan, setting the right amount for it, and timing it well all matter so much.
- When money goes up and down, morale can too. All the more reason to get really good with sharing often and directly with your team about what’s happening in your business and how they can influence it.
Pro tip: If you aren’t paying your team at market value, take care of that issue first before you work on a profit-sharing plan. Otherwise, if profits and profit-sharing payouts tank, so will your team’s morale.
Alternatives to Profit Sharing
If you’re not quite ready to roll out a profit-sharing plan, that’s okay. There are still other ways you can reward and inspire your team.
- Give a monetary reward for achieving a companywide milestone. Say, for example, you hit a certain number of new clients or reach a customer-engagement goal and want to celebrate the win with a bonus. Just be sure to communicate where the money is coming from and that it’s something you’re choosing to share.
- Fund education or professional training. People with inspired minds make better and more passionate team members. Online training, college courses and workshops can give your team members more confidence in their abilities, more appreciation for their company, and new skills to boost their performance.
- Give a $100 handshake. If a team member crushes a goal, surprise them with $100 cash or a gift card—something unexpected that thanks them for owning their role and doing exceptional work.
- Add an office perk. Does your team want comfier office chairs or a fancy cappuccino machine? Link an office upgrade to a goal—it’ll give them something to hustle for.
What’s Next: Hear From Top Experts on How to Build a Stronger Team
Remember that the purpose of sharing profits is to build, reward and keep a team of rock stars. It’s one more way to put your money where your mouth is. But before you think about sharing the profits, make sure you’ve got the support and resources you need to win. You can learn more about how to grow your business and build a stronger team by listening to The EntreLeadership Podcast. It’s full of business insights from today’s top leadership and personal-growth experts.
Frequently Asked Questions
What’s the average percentage for profit-sharing plans?
This is up to you and what works for your company, but a good place to start is giving 10% of your profits to qualifying team members. Of course, that percentage is spread among them, so choose a percentage that’s large enough that they’ll feel it but also makes sense for your bottom line. You may also find that sharing profits monthly will help your team feel the perk more than they would a quarterly bonus.
How is a profit-sharing plan different from a traditional 401(k)?
First, let’s clarify the plans you can offer. You can set up a stand-alone profit-sharing plan, standalone 401(k) plan, or a profit-sharing plan combined with a 401(k)-retirement plan. With those options in mind, you’re ready to tackle some details so you understand the differences:
- With a stand-alone profit-sharing plan, your team members don’t contribute anything. This plan is just for you to share a percentage of your company’s profits with your team.
- With a traditional 401(k) plan, your team members can contribute to their retirement savings with your company matching their savings up to a certain salary percentage.
- With a combined profit-sharing and 401(k) retirement plan, your team members can contribute to their retirement accounts, and on top of that, you can contribute to their retirement accounts based on your profits. But instead of a match, you choose how much (if anything) to contribute each year.
Who can offer a profit-sharing plan?
No matter the size of your company or its status as a for-profit or nonprofit, you can offer a profit-sharing plan. Of course, you need to be consistently profitable to make it a benefit that’s worth your while—and one that allows your team to see the value of it.
Pro tip: Read the IRS brochure Profit Sharing Plans for Small Businesses to learn more about how a profit-sharing plan works.