Why, When, and how to set up an employee profit-sharing program
If you want your business to be 100% black-owned and avoid selling equity in your business, profit sharing may be a good option for your startup.
Below I’ll share two examples of how entrepreneurs avoided selling off part of their company and then explain how to go about setting up your own profit-sharing agreement.
First, let’s talk about why you should consider profit sharing. When you’re trying to attract the best talent, you need to give them a good incentive to work for you. If you can not pay them their usual and customary rate, a portion of your future earnings is an excellent incentive to get them to join your team. When an employee is part of a profit-sharing program, they know that they will benefit from all the hard work that they’re putting into creating or supporting your product. It also gives them an extra incentive to do good work. There are times when a freelancer turns in sub-standard work because they are being underpaid. But when they know that substandard work leads to zero customers and zero customers leads to zero profit sharing for them, it increases the likelihood of doing quality work. Now they’re invested in the success of the product.
A few years ago, I had an opportunity to set up a profit-sharing system. I wanted to create five language learning podcasts for my language learning website. Lessons for one language were written by me. An outside contractor wrote one language, and the podcast’s hosts themselves wrote two. You may not want to be as generous as I was, but this is how I set It up. The podcast hosts that wrote produced and presented their own podcasts received 50% of the ad revenue that came in from commercials. The Podcast Hosts that only presented and did not write anything received 25% of the ad revenue from the podcasts. To make it official, each podcaster was sent a contract via hellosign.com, which outlined what was expected, quality guidelines, and the terms of the podcast royalty payments. They, in turn, signed it, returned it, and everyone had a copy of the legally binding contract. After that, every month, when I received the podcast royalty payments, I sent them their share.
My example was fairly simple to implement. Sometimes it may take a little more paperwork than that. An example of that is the case of Daymond John. If having a black-owned business is very important to you, Daymond’s example with Fubu shows another way to go about keeping ownership of your company. In his book, Display of power, John shares a story about his deal with Samsung. The initial offer that Samsung made would have given them 2/3 of Fubu. Eventually, they set up another arrangement, which allowed Fubu to remain a black-owned company. John created a Holding Company on top of Fubu. Then, he split the dividends from the Holding Company with Samsung. Sound a little confusing? I understand. All you need to know is that this arrangement somehow allowed John to still own Fubu outright.
When to do profit-sharing
Now I’ll explain When and how to set up an employee profit-sharing system.
When? Set up an employee/contractor profit-sharing system only when an employee/contractor has provided significant value to the organization and performed work that was directly linked to revenue creation.
A classic example would be a software developer that created an app for you by working for free or working for next to free. That would be an employee who should receive a portion of the profits from the app store. If 100% of your sales leads come in by phone, and an employee is answering the phone and setting up appointments for you, that employee is directly involved in revenue creation. You will be able to narrow these employees down by making a list of activities that are directly linked to revenue creation.
The next question to answer regarding when relates to the time frame. Should you offer profit sharing to an employee who has worked for you for a week? Of course not. Decide what would be a reasonable time investment that an employee should make in the company before profit sharing is available. For example, after 500 hours of work, the employee will be eligible for profit-sharing, or after completing a fully functional app, the employee will be eligible for profit sharing. Just remember to keep in mind that depending on your situation, this profit-sharing agreement may expire when the employee leaves the company.
How to set up a profit-sharing program
Now that you know when it is appropriate to share profits, the only question left to answer is how. The first thing you’ll have to decide is how much would be a reasonable amount to share. Using the example of the employee who becomes eligible after 500 hours, the profit-sharing contract would include some version of the following text. After 500 hours of work, the employee will become eligible for profit sharing, and the amount will be ______% of (time period)ly profits. Profit sharing can be done monthly, quarterly, semi-annually, or even yearly using the same payment method that you use for all your other payments to the employee. If you have a lot of employees, the amount may be 1% or less. Take a page from Nathan Berry of Convertkit’s book. Get a spreadsheet and map the whole thing out.
So, if you’re trying to attract the right talent to your business and can’t afford to pay them $100,000 a year, there is a way around this. As long as your business is profitable or has the potential to become productive, it is still possible to attract great people to your startup. Consider rewarding your people with profit-sharing as a viable option for growing your startup.