Bonuses and profit sharing

By Christopher Freeburn


One of the most important tasks facing every small business owner is keeping his or her employees well motivated. Happy, well-motivated employees work harder and longer. But the benefits to your business go far beyond simple increased productivity. Indeed, for very small businesses, happy employees are absolutely crucial to success. In smaller workplaces, individual employees have a greater impact on the overall business because each employee typically wears so many different hats. Additionally, your employees' attitude toward their jobs and your business will likely be perceived by your customers, who will then form opinions about your business based on their interaction with your personnel.

One obvious way to motivate employees is by providing some form of additional compensation for specific performance. This is usually called a bonus. Bonuses can be dispensed for achieving some overall goal--a certain percentage improvement in yearly sales or volume of product produced--or for more narrowly defined tasks, like the completion of a specific project.

Bonuses can be handed out on an individual or group basis. Many business owners assume that handing out bonuses on a group basis will forge a spirit of teamwork and camaraderie among their employees. But often, the opposite can occur. "There is some danger in awarding group bonuses," cautions James Sheridan, a Boston-based financial consultant. "When a bonus is handed out on a group basis, it can accidentally increase office tension by pitting employees against each other."

If the group encounters difficulties meeting the required goals, for example, employees who were anticipating the bonus may begin blaming other employees for the problems. Likewise, if some employees feel that some members didn't contribute fully to the overall team's achievements, the bonus program may end up being perceived as unfairly rewarding the weak at the expense of the strong. "Instead of a smooth functioning team, you might end up with a bitter, divided group of employees, each blaming the others for failing to meet duties."

This danger is avoided by handing out bonuses on an individual basis. "Not only do you avoid creating unnecessary tension in your office, but you increase the personal loyalty of your best employees to you and your business," says Sheridan.

Another way to reward employees for their efforts is to create a formal profit-sharing plan. Under such a plan, a business owner designates a percentage of the business's pre-tax profits to be distributed among the employees. Profit-sharing plans are regulated by federal law and must meet contribution and reporting requirements. Unless otherwise specified by the company, any employee who has worked 1,000 hours or more for the business over the preceding year is eligible for such a plan. The business's contribution can vary from year to year, but it is generally pegged at a value between 20% and 25% of net profits. (To download a sample profit sharing plan, check out the U.S. Chamber of Commerce's Small Business Nation website here:

"The benefit of a profit-sharing plan is that it can increase employee loyalty to the company by tying compensation directly to the company's bottom line," says Sheridan. "If the company does well, so does the employee." This can motivate all employees to work harder since it lets them know that going the extra mile for the company will ultimately be rewarded. It can also provide them with a sense of ownership of the business's success, without any actual equity position.

There are downsides to profit-sharing plans. If your business experiences large shifts in profitability from year to year, a profit sharing plan might not be a good fit, since workers might not feel particularly rewarded during "down" years--like during the recent economic downturn--for the business when profits have obviously fallen. Also, profit-sharing plans can place too much emphasis on profitability, which can become a problem in times when the business needs to invest its profits in expansion or weathering difficult markets.

Due to the legal requirements imposed on profit-sharing plans, administering such a plan can also be complicated and time consuming. "Most businesses that offer a profit sharing plan seek an outside financial advisor to run the plan and maintain legal compliance," notes Sheridan. This can become expensive, especially for small businesses. (For much more on how profit sharing plans operate and the legal regulations that govern them, check out the Department of Labor's profit sharing plan web page here:

Writing it down
"Before you announce any bonus or profit-sharing plan to your employees, make certain you have worked out all the rules in advance, and that you are prepared to put those rules in writing," says Sheridan. The rules should spell out clearly exactly who is eligible for the bonuses and profit sharing, what must be done to receive it, how such compensation will be dispensed, and under what circumstances employees might forfeit their right to receive the benefits. "We live in a time when employees are quick to sue over any perceived slight," warns Sheridan. "Even long time, trusted employees can quickly become disgruntled and angry is they think they aren't receiving money they assumed they were entitled to." The only way to protect your business from hurt feelings and--worse--litigation, is to make certain that every aspect of the plan is in plain writing for everyone to see.

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