Spreading the wealth to employees when times are good can be a valuable motivational tool — and it’s not just a big-company perk.
The business is doing well and you’d like to show your employees some extra appreciation — and maybe encourage them in a meaningful way to keep up the good work.
Consider profit sharing.
We mostly think of profit sharing as a big-company benefit. Where I live and work, in Racine, Wisconsin, home care products giant SC Johnson is famous for doling out hefty profit-sharing bonuses to all employees. It’s so well known that some big-ticket retailers, such as car dealers, have tied sales promotions to the annual profit-sharing payday.
But what about small businesses like yours? Can a small septic pumping business really set up a profit-sharing plan? Is it worth considering?
WHO SHARES PROFITS?
The consensus among economists is that profit-sharing plans boost productivity. How much is hard to say, because plans and the companies using them can differ widely. Still, the general trend favors them, as a 2010 report from the National Bureau of Economic Research found.
Roughly one in five employers offers some kind of profit-sharing plan, says Kerry Chou, an expert on the subject at WorldatWork, an organization that offers advice, training and certification programs for human resources professionals. WorldatWork’s primary focus is on pay, benefits, work-life matters, and strategies to attract, motivate and retain employees.
The available statistics don’t detail whether the companies that participate in such plans are most likely to be large, small, or in between, but Chou is confident that size doesn’t matter: “Profit sharing can be an effective plan at any-size company,” he says. “It promotes the cultural element in the company that we’re a family — we’re going to win or lose together.”
They have other things going for them. “One of the biggest advantages to a profit-sharing plan is that, regardless of the company’s size, it’s very simple to understand,” says Chou. “If the company makes profits, we are simply going to be sharing those with the employees.”
The typical profit-sharing plan is just what it sounds like: The employer takes a fixed percentage of company profits and pays that money out in the form of bonuses to employees.
HOW TO PAY?
The bonus is typically an annual payment, although nothing stops a business from making payments more frequently — once a quarter, for instance.
It’s also possible to set up a deferred payment plan — contributing the bonus to an employee’s 401(k) or other retirement plan, or breaking a payment into two chunks paid over two years “so the employees have to stay another year to get it,” Chou says.
But variations like those can make accounting a lot more complicated — and also less powerful as an incentive because deferred payments “are less of a value to the employee,” he notes.
“The predominant practice is to simply cut the employees a check to give them the actual cash,” Chou says. “Most employees like cash because they can spend it right away.” And if they want to invest it on their own, they can simply do that.
You’re sold on the idea — so what do you do next? Step one, Chou says, is to determine competitive pay levels for the positions at your organization. Check with local wage surveys (there are many sources, including state and federal agencies, your local employers association, and private consultants) to see where you stand. Don’t simply look at base pay; see what forms of variable pay, such as profit sharing or other bonus plans, prevail in your area as well.
Then identify some expert advisers who understand how profit-sharing programs work — a human resources consultant or a suitably qualified attorney or certified public accountant.
The typical plan may set a flat percentage of net income or of EBIDTA — Earnings Before Interest, Taxes, Depreciation and Amortization — to be distributed, usually after profits clear a certain threshold. But you don’t want to make the choice off the top of your head.
Instead, Chou says, take a close look at how much you can realistically afford to share and how much you are willing to pay out if profits hit the target at which the bonus is triggered. Of course, you’ll need to think hard about what that target should be in the first place.
There’s also the question of how to divide the total pool. Again, Chou says, your compensation survey information will be important.
Some employers might take the position that everyone should get the same amount, perhaps with incremental increases based on how long a person has been with the company. But market considerations lead most to scale the bonus according to management rank, he says.
Line workers, for instance, might get a payment amounting to 5 percent of their base pay, while higher managers’ bonuses might be 10 or even 20 percent of base. In essence, that means the higher a person is up the ladder, the more of his or her pay is at risk.
CHECK THE FINE PRINT
There aren’t a lot of regulations over profit-sharing plans — but there are some.
An important thing to remember, Chou says, is that under federal wage-and-hour laws, the typical profit-sharing payment is generally considered part of an employee’s regular rate of pay. That’s because it’s “nondiscretionary” — the employer has committed in advance to paying the bonus if a certain target is met.
This becomes especially important when calculating overtime pay. Because the profit-sharing bonus gets added to the employee’s earnings, it effectively increases the individual’s standard hourly wage. That also leads to an increase in the employee’s overtime premium (half the hourly wage, paid on top of the regular wage for overtime hours). When the profit-sharing bonus is paid out, a sum representing that retroactive additional overtime pay must be paid out, too.
“One thing employers need to do is make sure that their payroll departments are able to get those numbers included, and make sure that a retroactive payment is made if additional overtime is required,” says Chou. Failure to do so could lead to fines and other penalties in addition to an order to pay the back wages owed.
“Discretionary” bonuses — awarded at the whim of the employer with no advance communication to employees — don’t have to be included in overtime calculations. But they limit the ability to motivate performance because you didn’t tell employees in advance about them — or how to earn them. And if the employer awards such bonuses every year, they may become an annual expectation and may be viewed as nondiscretionary in the event of a wage-and-hour regulations audit — and once again, make the business subject to penalties.
“It’s much better just following the law,” Chou says.
A BIG THANK-YOU
All those considerations point to the care required when setting up a profit-sharing plan. But if it’s something you can afford, it may be well worth it.
After all, what better way is there to tell your workers that everyone’s in it together?