How does profit sharing with employees work?
5m read
To retain current staff or attract top candidates for available positions, businesses can distribute a portion of their yearly profits through profit-sharing agreements. This article highlights a selection of the profit-sharing options available to businesses as Employee Share Ownership Plans (ESOP).
Understanding the concept of a profit-sharing plan
Profit sharing is a way of awarding employees a percentage of the company’s profits. The amount offered is based on the company’s earnings over a set period and is applied when the company sees a profit. Businesses that distribute these profits to their staff can do so through cash, contributions to retirement plans, company shares, or bonds.
These profit-based employee incentives are usually paid in addition to regular salaries. These arrangements are a great way to expand benefits for existing workers and a way for a business to give its employees a sense of ownership in the company. Any employee may be included in a profit-sharing scheme or only employees in specific roles, such as managers and executives.
When should a business consider profit sharing with employees?
Profit-sharing plans are available for a business of any size. A company usually decides to share its profits after showing a profit for a specific period or as part of salary negotiations for a senior employee.
Although most companies award a share in profits after calculating annual income and profit, some organisations prefer to pay a share of profits to employees quarterly. Making regular payments makes it more likely for the company's profit share recipients to be motivated throughout the year.
The amount of money and distribution method for sharing profits with employees varies among companies aiming to increase productivity through motivation. Part of creating the optimal employee profit share scheme is laying out what to contribute (cash, shares or bonds) and who will benefit. Companies should first conduct a cost-benefit analysis before choosing to implement any plans.
Benefits of sharing profits with your employees
As well as benefiting your employees, profit-sharing plans will positively affect your company. Below are some examples of how incentivising and retaining the services of your best employees will boost your business.
Sense of belonging to the company
A company has a better chance of retaining its best employees if it distributes a portion of its profits to them. Employees whose pay is positively affected by the business profits tend to be more engaged and loyal to the organisation, investing more effort in its long-term success. Staff experience a greater sense of ownership in your organisation and take more control over their financial prospects.
Increased employee productivity
The main benefit of sharing a company’s profits with employees is increased productivity. According to Gallup, a global analytics and advice firm, companies with highly engaged staff score 17% higher on productivity. Knowing that working harder is very likely to improve their finances usually proves a compelling incentive for staff, as opposed to receiving a fixed paycheck regardless of the quality of their work.
Another option is increasing employee engagement through ESOPs, ensuring that your valued staff see longevity in their employment with the company.
Costs proportional to profits
When profits are low, the amount of money that needs to be shared with staff on these plans decreases proportionally, adding stability. Profit sharing can therefore be an effective tool for small businesses as well as larger ones due to lower payments and contributions when less profit or no profit is generated at all.
How does profit sharing work?
Typically, businesses choose a specific portion (or ‘pool’) of company shares to allocate to employees for profit-sharing schemes. Because a higher profit margin automatically means a larger amount of money for distribution, this strategy keeps employees aligned with bottom-line performance.
Companies can distribute shares equally among employees as a percentage of their salaries or based on each person or department's contribution to the company’s success. Some businesses limit who qualifies for profit-sharing plans, granting these extra benefits to essential personnel only. Find out more about how to allocate ESOP in this article here.
Once a company decides how much profit to share, it’s time to implement some plans.
Adopt a written plan
Companies create a written document establishing a foundation for profit sharing. The plan document will determine how contributions are awarded to eligible employees and a vesting schedule (when the shares will become available). The paper should outline day-to-day operations and include profit-sharing calculations, employee eligibility guidelines, a vesting schedule, and how the business intends to deposit contributions.
Arrange a trust for the plan's assets
It’s recommended that any shares related to an employee share plan be held in a trust; that way, employees can be sure the assets are used exclusively to benefit them. It must have at least one trustee to handle all contributions and distributions. Using a trust to manage its assets lets a trustee control contributions, investments and allocations to ensure the plan maintains financial security.
Provide information on the plan to eligible employees
Businesses need to notify all eligible employees to participate in the profit-sharing plan's features and benefits. The company must also share a summary plan description (SPD) with all participants.
Employers sharing profits with employees must follow the terms of the company’s profit-sharing plan documentation. Profit-sharing companies, however, have lots of flexibility within those terms to limit contributions during years of decreased profit or boost contributions during particularly good years.
Organisations should keep detailed records on how the plan is distributed amongst employees (see understanding how ESOP shares are allocated).
Each type of ESOP works differently, with various ESOPs better-suiting companies in different ways. Explore the type of ESOP - whether options, loan to purchase, phantom or bonus share schemes - before choosing your chosen plan, and consult the ESOP vesting guide.
Choosing the best ESOP management software
If boosting your company’s competitive advantage relies on keeping key personnel or attracting the best people for the job, offering an incentive to stay and perform will be hugely beneficial.
Using ESOP management software is the easiest and most organised way to share profits with your staff. There are numerous options available when choosing ESOP management software, and Orchestra can help you determine the best fit for your business and employees.
Contact Orchestra today to discuss how we can help you in all aspects of profit-sharing.
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DISCLAIMER: This article is for informational purposes only, and contains general information only. Orchestra is not, by means of this information, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests. Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor. This information is not intended as a recommendation, offer or solicitation for the purchase or sale of any options or shares.
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