Having a profit sharing plan for your company is an excellent way to engage your employees and investors by giving them skin in the game in your business’s success.

It will make workers feel as if they have a clear purpose and goal with their job. That is one of the key factors driving motivation and retention, according to Gallup’s State of the Workplace report. Today’s workforce is more likely to bolt if their needs aren’t met or if an employer fails to provide the benefits they want. Only about 20 percent of organizations offer profit sharing.

However, it’s a desirable perk with 40 percent of employees willing to change jobs to get it. But it’s a daunting task to develop, fraught with legal pitfalls that you know need to know.

Steps for Developing a Profit Sharing Plan

Developing a Profit Sharing Plan

Writing this document isn’t something to rush into without some careful consideration. While you can draft one yourself, you might think about having a third-party take charge of this task. It’ll save you time and effort. Also, it’ll give you the benefit of having an independent advisor with a free perspective of your business cost reduction. It involves the following milestones:

  • Affordability
  • Type
  • Documentation
  • Conditions and Implementation

The essential thing to remember is that plan is the operative word. You, as an employer, decide how it works and how much each employee will receive—all subject to change.


Lady presenting a Profit Sharing Plan

The first question you have to consider is whether your business can afford to give this benefit and how much you can reasonably offer. The upper limit is less than 25 percent of worker’s pay or more than a couple hundred bucks. The chances are that you probably won’t reach or afford to be quite that generous. What you share varies with the kind of company. You can opt for bond, stock, or cash.

Also, think about your own motivation in providing a profit sharing plan. Often employers offer them as a retirement benefit or for when an individual parts ways with the organization. You can address these factors in its conditions.


Executive meeting about profit sharing plan

Next, consider the type of plan. There are three basic kinds:

  • Direct Cash
  • Gain-Sharing
  • Deferred Payment

We’ll discuss each one in detail.

Direct Cash Plan

A direct cash one, for example, acts as the term would suggest. Employees receive some predetermined amount or percentage of the business’s profit. The advantage of going this route is that it’s simple for both the employer and workers. You can tie it to a flat percentage or number of stocks.

It’s an excellent way to build trust because it allows for transparency. It’s the classic win-win situation that motivates employees to work harder in the interest of the organization. However, calling it simple belies the fact that you can use it with a larger company where there are more than one income streams.

It walks a fine line between a perk and a source of dissatisfaction for individuals on the lower end of the pay spectrum. There’s a risk that some may feel under compensated if they have a smaller role in the operation of the business. Their concern is valid. However, it’s not the only option that you have.

Gain-Sharing Plan

You can also implement a gain-sharing plan. This is a wise choice in situations where labor and productivity have a key role in profits. Instead of compensating based on a percentage, you bonus employees based on cost-savings. It’s a good way to reward individuals when their performance is gauged on production.

It creates a sense of fairness and ownership in one’s work that can far exceed the benefits of setting quotas. It puts the employee in control which can lead to great job satisfaction. It’s also measurable. An individual knows where they stand and knows what they need to do to improve their earnings.

Deferred Plan

Finally, the deferred plan is just what the term implies, delayed compensation for profit sharing. You can choose to offer either cash or stock. Employees receive the total of your contributions when they leave the company. It has both pros and cons for everyone concerned. The worker avoids paying income tax on these earnings.

Likewise, employers can treat them as business expenses for tax purposes. It shows one example where getting a third party to manage it. It involves more work for the company because of regulations.


Professionals documenting a profit sharing plan

With the preliminaries decided, the next step is to create the documentation for the profit sharing plan and also know how to make a budget plan.  The language must be clear and explain all rules and conditions implicitly.

That includes any provisions dictating contributions. It makes sense for employers to have the latitude to review it on an annual or fiscal basis. It’s not unusual for the percentage to vary each year. You can think of it as a work in progress that will evolve with your business.  This is not something that you set in stone but rather fine tune to ensure its efficacy.

Often a tightrope walk between what you feel is fair and what employees expect to earn. It’s another incidence where transparency is imperative. Structure your document so that it includes its purpose presented in a straightforward manner. If you have an allocation formula for compensation, explain it too. To avoid confusion, define all parties and terms so that anyone reading it can understand it.

Include specific information of how the monies are calculated. And don’t forget to add a right-to-amend clause.

Again, in the interests of transparency, you can also provide a financial statement. You can think of it as a SMART goal, i.e., a measurable one that can resonate with your employees and offer further motivation with their vested interest in the success of the company and ​best ​budget ​for ​your ​business.

It also fosters a team atmosphere that can spill over into other aspects of the business.

Implementation of Profit Sharing Plan

Girl creating on her laptop a profit sharing plan

We’ve touched on some of the pitfalls of a profit sharing plan that mainly concern fair compensation. It’s vital that the allocation doesn’t favor one group of workers over another. Rather than being a motivating tool, it can have the opposite effect. Therefore, proper implementation depends on having a keen understanding of your business and its future.

Ultimately, it’ll allow employees to become stakeholders. It’s essential to consider your workforce and their needs.  For example, millennials prefer perks with real-time benefits, making direct cash or gain-sharing plan more desirable.

An older employee base is more likely to stay with one company longer and feel well-compensated with a deferred plan.

If your organization changes its contribution, it’s crucial that this information is forthcoming. Otherwise, it defeats its purpose for raising worker morale. Your plan should include provisions for making these points clear.

Profit Sharing Plan: Final Thoughts

professionals discussing profit sharing plan

Offering a profit sharing plan is an excellent way to attract quality talent to your business. You can think of it as an investment for its future viability. The most important things to remember are that it must serve its purpose in a way that makes sense for both you and your employees. It is an effective way to engage your staff in improving retention.

The key is to create a plan, also based on profitability,  that is straightforward with the flexibility you need to let it evolve as your business grows. A clear direction is the surest path to success.