Businesses are constantly looking to increase employee performance and productivity. This has resulted in a number of companies introducing employee incentives, including company perks, bonuses, extra days off and more. Profit sharing has been proven as a successful tactic for mobilising and motivating employees. This Business Kitz blog will walk you through all the basics of profit sharing with employees and the potential benefits for employee performance.

What is profit sharing?

Profit-sharing allows employees to receive a direct cut of the company's profits. The earnings received by an employee under this plan are entirely dependent upon the company’s profitability, their wages, bonuses and the share percentage that the employee holds.

How does profit sharing work?

Profit sharing is an innovative employee incentive that provides employees with a stake in the company. The goal of this structure is to motivate employees to work harder to increase profits, as their income will also increase accordingly. Under a profit-sharing agreement, employees are given a certain percentage of the company’s profits, which are calculated based on the business’ earnings over a certain period of time, and is typically awarded once annually. This strategy differs from traditional employee bonuses, which are typically based on employee performance and are not directly tied to or dependant on company profits.

Profit sharing is generally outlined in a profit sharing plan. Such plans can allow businesses to distribute percentages of the company's profits with their employees. 

What are the different types of profit sharing plans?

There are generally four different kinds of plans that a business may adopt to implement a profit sharing plan:

1. Pro-rata Plan: The benefits of profit-sharing is divided among employees based on their typical contract wage. This means the more the employee earns, the larger percentage of profits they will receive.

2. Fixed Percentage Plan: All employees will receive the same percentage of profits no matter how much they earn in their contract.

3. Age-Weighted Plan: Employees will receive a larger percentage of profits as they get older. This is a strategic incentive to retain staff members and encourage employees to save for retirement. 

4. New Comparability Plan: Employers will give different percentages of the company profits to employees based on a range of factors which may include the amount of hours an employee works, their age or their contract.

What is a profit sharing agreement?

A profit sharing agreement is a legally-binding contract which outlines the terms of how you will divide the profits within your business. We see these documents created and implemented when two separate companies embark on an unincorporated joint venture. Thus, while these companies remain distinctly separate, they work together to complete a project or deliver a service. However, it is essential to ensure the profits are fairly distributed, and the details of the distribution are agreed upon and recorded in writing to protect both parties, via a profit sharing agreement. If you are looking to implement a high-quality agreement, Business Kitz's subscription service includes a profit sharing agreement.

When forming this contract, parties should engage in negotiations, record the details of the agreements and sign all necessary documents before they enter into a partnership project. This negotiation will factor in the different skills and capabilities that each business or employer is bringing to the project. Once an agreement has been reached, the division of profits will most likely reflect this split in responsibilities, contributions and risks between each party. For instance, a business with more intensive duties and greater risks may negotiate for a high-profit margin under the agreement. 

These types of contracts may also be used in part-time or full-time employment contracts, independent contractor situations or any other business relationship of two or more parties where everyone agrees to split the profits for a period of time.

If you would like to learn more about profit sharing agreements, click here to check out another related blog!

What are the benefits of profit sharing?

There are a number of different benefits that profit-sharing can provide for both the employee and the employer, including:

1. Employees feeling a sense of ownership within the company. As a result, this will encourage employees to work harder within the company, knowing that they are reaping the benefits of their work.

2. Strong employee motivation - Profit sharing incentivises the company's ability to make a profit, causing employees to be highly motivated to work towards a company profit as they are compensated accordingly. 

3. Increases company loyalty - Profit sharing often encourages employees to remain loyal to their company as they hold a sense of ownership within the company. Further, they are more inclined to commit to the company if they wish to maximise the benefits of their profit sharing arrangement. This can also vary depending on the type of profit sharing plan. If the plan relies on company experience and salary, employees will be encouraged to grow within the business. 

4. Improves employee performance - Profit sharing has been proven as a successful tactic to improve employee performance. This is as a result of employees aiming for a higher amount received from the profit-share, meaning if their performance improves, so does the likelihood of a higher return. 

What are the disadvantages of profit sharing?

Employees

• Some employees may not be able to see how their contributions have an impact on the overall profitability of the company.
• Employees are not guaranteed extra income if the company does not acquire a substantial profit
• Employees be taxed when they receive their share of the profits of the company or when they leave the company.
• Profits shared to an employer may have consequences on their individual tax obligations.
• The agreement may not cover who pays the tax and when it is to be paid, which could cause legal issues for either party.

Employers

• Fringe benefits tax implications which means that employers are liable for the fringe benefits tax the employee receives.
• May experience issues in terms of how the company is valued, the proportion of profits to be paid and when they are to be paid.
• The employees may have additional stakes within the business, that were not intended, such as voting or other rights in the company.

Are you interested in Profit-Sharing?

Save your company thousands in legal fees with our Australian Profit Share Agreement Templates drafted by top-tier Australian lawyers.

Legal Advice

Profit-sharing can only take place if it is set under a certain agreement. If you feel as though you have not received a share of profits that was previously stipulated by your employer, or have any further questions around your rights regarding profit-sharing, as either an employee or employer, our sister company, Legal Kitz can assist you. To arrange a FREE consultation with one of their highly experienced solicitors, click here today, or contact us at info@legalkitz.com.au or 1300 988 954.