DESIGNING AN EFFECTIVE PROFIT SHARE PROGRAM
A core tenet of steward ownership is the idea of sharing economic rewards with stakeholders who are contributors to furthering the business purpose and its success. For most steward-owned companies, employees are key stakeholders for whom they want to designate a portion of the profits. While many of the companies that we work with already have a plan in place for sharing profits with employees, transitioning to a new ownership form gives them a chance to take a deeper look at their profit sharing programs, including their underlying philosophy and methodology.
In our previous blog, Employee Ownership: Cash Now or Cash Later?, we made the case that what attracts many companies to steward ownership is that profit sharing is a highly flexible tool that can be designed to align with a company’s cash flow cycles, its culture, and the needs of its workers. With such a wide open canvas, where do you start?
To help our clients build out their profit-sharing design, we start with two key questions:
How much to share?
A good place to start is with a framework for determining your Profit-Sharing Pool. Many companies take a “free cash flow” approach to determining how much will be available to share each year. Free cash flow is the cash available after the business pays out operating expenses and makes strategic investments, meets its obligations to banks and/or investors, and sets aside reasonable cash reserves to weather any unforeseen circumstances. We often refer to this as a “cash flow waterfall,” and it can be useful to share this analogy with staff to help them understand what financial goals need to be met in order for there to be funds available to distribute.
The critical decision comes with how to use that free cash flow – how much of it to set aside for your profit sharing pool. Will it be a discretionary payment approved by the Board of Directors each year, or a set % of free cash flow? And what happens if there are no meaningful funds in the pool to share?
Who gets what?
When the pool has money available to distribute, the next question becomes: how to allocate it among employees. There are four dimensions to consider in customizing your plan:
Timing: What are the company’s seasonal cash flows? Does it make sense to do quarterly, semi-annual, or annual payouts? If done more frequently, will the payouts feel meaningful to employees?
Weighting: Should profits be shared equally across all employees based on hours? Or should the method funnel more of the profits to those who have more tenure, more responsibility, or better performance?
Eligibility: Will there be a waiting period before eligibility kicks in? Will part-time employees participate? If an employee leaves before year-end, will they be eligible for a payout? Are there any specific criteria that can be used to reinforce development or mission-related goals?
Form: Cash is the most common form of profit-sharing, but some companies choose to supplement cash with contributions to 401Ks, employee wellness programs, or other benefits valued by their employees.
Below are a few examples of how a profit-sharing plan can be designed to align with a company’s values and with the behaviors it wants to motivate:
Weighted Towards Tenure: Organically Grown Company
Our parent company’s 20% profit-sharing pool is allocated to their 250+ coworkers based on hours worked and years of service. Coworkers are eligible after 90 days of employment. Each coworker gets one (1) point for each hour of service during the previous year. The number of points earned is increased by 5% for each full year of service completed, so in this way, tenure is highly rewarded (although the 5% kicker caps out at 10 years tenure). The total available pool of funds is divided by the total points in aggregate for all coworkers and then multiplied by the individual employee’s number of accrued points to arrive at their payout.
The formula does not factor in wages at all, so those with varying degrees of responsibility (from warehouse workers to the CEO) who have equivalent hours and tenure will receive the same profit-sharing amount.
Note: regular readers of our blog may recall that OGC coworkers have a chance to share in additional profit sharing beyond the guaranteed 20% pool as part of the company’s cash flow waterfall “upside dividend.” You can read more about that here.
Weighted Towards Responsibility: John Lewis Partnership (UK)
At the world’s oldest and largest Employee Ownership Trust, 82,000+ partners are eligible for profit-sharing after 90 days of employment. During their highly anticipated annual meetings, the profit-sharing percentage for the year is announced, which is then applied to each employee’s salary. Since it is based on wages, those who have more responsibility (which is reflected in their salary) will receive higher payouts. There is no specific reward for tenure or distinction made between part-time, full-time, or seasonal, but responsibility can be viewed as being rewarded twice, once in the salary and then again in profit-share.
Aligning with Mission: Organic Valley Cooperative
Organic Valley’s profit-sharing pool is divided among their 950+ employees in a unique plan based on mission performance. Throughout the year, employees can earn points in their Employee Growth Incentive Program for participating in activities aligned with their mission. This could take the form of engaging in community events, completing career development courses, or participating in personal health and wellness activities. Those points are then used to calculate an employee’s percentage of the pool.
OV’s plan rewards individual contribution to the company’s mission and culture and their own personal growth. There is no distinction in this framework related to job responsibility, wages, or tenure. There is, however, some subjectivity about what is eligible for points and is of value, making this a more complex plan to administer.
Flat and Equitable: Equal Exchange Cooperative
At Equal Exchange, each worker-owner invests an equal share into the business, and in exchange they receive the right to one vote, the right to access shared financial information, and the right to an equal share of the profits. This is the simplest framework in that it makes no distinction based on tenure, job responsibility, or wages. The only eligibility criteria is completion of one year of tenure.
Whichever profit-sharing plan a company chooses to implement, it is imperative that the design of the plan, including the philosophy and methodology, be shared with all employees from day one. When paired with other tools such as open-book management, profit sharing can be a key component in building a co-ownership culture that can benefit individuals and companies alike.
