Sharing Profits, Not Equity

Sharing Profits, Not Equity

When I worked for large companies, the concept of profit sharing was limited to the upper echelons of the organization generally in the form of annual bonuses that were mysteriously calculated, paid 3-5 months after the end of the year and reserved for the “fat cats” in the organization! The individual contributors, clerical and shop/line employees were never eligible; they were the “mice”!

As the CEO of the company you purchase, you can rectify this imbalance and craft a compensation system that is right for all levels of company, and let everyone be recognized for their effort on payday. Figuring out the best way to “give back” some of your profits to employees will result in a loyal and engaged workforce.

Wait until you have profits

The first rule for profit sharing is: no profit = no payouts. Sounds simple, but “effort” is not enough, net income is what counts. Use earnings after interest and before taxes. EBITDA is for the PE firms to work with, not for paying cash bonuses to employees. Of course, if there are losses, you cannot expect employees to accept loss sharing; they will understand that they get nothing. In my own company we targeted 10% net earnings for distribution, but we never communicated an exact formula; it was just too complicated and fraught with misunderstandings in trying to explain GAAP accounting principles. We even used the same formula when the business was sold to distribute a portion of the selling price.

The second rule is to pay out distributions quarterly, as close to the end of the quarter as possible, as soon as the books are closed for the last month. Employees react much more favorably when they don’t have to wait for an annual payout; after all, they have immediate bills to pay and dreams to spend it on. Yes, there are always some end-of-year accounting adjustments but not worth waiting for, given the benefit from having 4 opportunities to celebrate during a year.

Pay attention to how you make the payments

On payday, provide employees with a separate “profit sharing” check; not everyone wants to have their payment combined with their weekly paycheck…don’t ask why! Consider paying 2/3 in cash and directing the balance to employee’s 401k savings plan. Over the years, these accumulate along with employee and employer contributions to safeguard their retirement. Working for the entire quarter is a requirement for eligibility, so new employees get their first distribution after their first full quarter with your company.

Now for the most unusual element of the system—all employees get the same amount, regardless of seniority or pay level. That’s right, the sales manager gets the same as the second shift clerk. The rationale is that everyone contributed to the success of the company for the quarter, and salary levels account for skill and competency but not for “effort”. Seniority can be rewarded separately with longer vacation time allocations and perhaps a step-level contribution to health care benefits. Individual performance is the basis for merit based pay increases. This puts your money where your mouth is – every team member matters.

Employees understand this profit sharing approach, see its fairness and can see that new orders, cost reductions, pay raises, and even layoffs all have an impact on their quarterly profit sharing check. I found it to be a great way to reinforce an “ownership” culture.

Hold equity dear to your heart

Sharing equity at the business you buy is problematic. You are not running a high-tech “start-up”, nor a company that will soon go “public”. Employees are not putting their cash into the company like your investors have done. Vesting systems have a way of keeping the wrong employees longer than they should. Valuing the company is expensive and fraught with distrust.

Equity may be the “currency” that drives you, but don’t assume that it is at the top of your employee’s list. Equity is not liquid, won’t pay their bills and most front-line employees would much rather see cash in their pocket than some form of “percentage” of ownership.

At your executive staff level, a performance bonus system can be developed that rewards results based on specific personal and company performance objectives and paid out annually, tied with budgets and goals. This cash based system will aid in recruiting and motivating your direct reports.


Over a period of years, this profit sharing system will result in a loyal workforce and employees who are aligned with the business objectives of making a profit, every quarter, and sharing the profits equitably. It allows you to put any bad quarters quickly behind you and stay focused on the future. Don’t tweak it much. When there is an exit, consider what contribution the employees made to reaching that objective and reward them appropriately.

The autonomy and independence that you have as a business owner gives you the freedom to design your own performance reward systems. However, doing so comes with significant responsibility. Tread carefully! I learned that there are two things dear to employees’ hearts that must be thought through very carefully from their perspective and not mine—their pay, and their lunch break!

Operate on!

Feel free to share some of your own best practices or experiences in dealing with these issues in the blog comments. I encourage comments and dialog, allowing all to learn from both my views and the views of others – a virtuous learning cycle. Jump right in! I regularly update individual blog posts, add to the Reference section and Search tips, so visit the website regularly.

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45-“Strategic partners” are very important to the business searchers.You want to rely on some trusted providers to support your business, you can’t do everything yourself!(See Blog Post-Strategic Partnerships)

42-Start early on legal documents, they often delay closings while under LOIBoth the searcher and the seller are plowing new ground and it takes a while to comprehend the meaning of all of the legal details .(See Blog Post-Getting to closing)

63 Searchers make promises they can meet to build trust with sellers. It is important to provide incremental opportunities to show that you can be counted on to deliver.(See Blog Post-Building Trust with Sellers)

34 Searchers who get access to employees before closing are more likely to close. Once the seller begins to confide in their employees about the sale of the business and introducing you as the “new owner”, they are more likely to proceed to finalize the transaction than to change their mind at the last minute.(See Blog Post-Getting to Close)

07-You are not a PE firm, don’t act like one!
Potential sellers resonate with your taking over their legacy, a PE firm is simply adding to their portfolio. Make sure your website looks personal and non-intimidating.

04-Fight Seller Fatigue in Due Diligence!
Sellers get worn out in this process. It is highly emotional for them, probably their first time at relinquishing their “baby” to someone else. During LOI stage, make it a practice to communicate with them, in person or by phone, every 2 days.

53-Holding monthly “all-hands” meetings indicates your transparency. Trust employees with what is going on with the business and they will trust you more .(See Blog Post-Communicating with Employees)

06-Use metrics to drive decisions
Track what is most important for your search – getting in front of prospective sellers to make offers to buy their business. Track the number prospects, IOI’s, LOI’s and set goals for yourself! If you measure it, you can improve it.

22-When in conflicts arise, remind professional advisors they work for you.
Inevitably, you will disagree with some advice you are getting. After checking multiple sources, do what feels right to you and move forward. You will have to “live” with your own choices, not the professionals!(See Blog Post-Professional Support)

18-Every day that goes by during Due Diligence raises the chance that you won’t close!
Time is of the essence when it comes to moving from a signed LOI to closing on your business. Seller fatigue sets in as the closing date gets extended and the seller constantly re-evaluates their motivation to sell. Only you can push the process along.(See Blog Post-Due Diligence)

44-Plan ahead, give thought to the small details of how you present yourself as the new owner. The first introduction to the employees of the business has a huge impact so you want every word to be rehearsed!(See Blog Post-Taking over the business)

50-Don’t expect immediate “loyalty”, the previous owner earned it, it takes time. You will need to earn the trust of your employees by your actions, not your words. (See Blog Post-Seller Tranisition)

35-Searcher CEO’s need to be prepared to walk away from volume orders if margins will decline. It takes a forward thinking CEO to seek out higher margin, value added opportunities to grow profits, not revenue.(See Blog Post-Wearing the sales hat)

09-Learn from others – read case histories
Over 40 case histories have been written about funded and self funded searchers in a variety of industries and historical settings. Each have great “lessons learned” and are worth the $10 cost to read them. Searchers are learners!

39-The business seller is “hiring” you to run their business. The owner trusts you enough to turnover the “legacy” of their business to you. (See Blog Post-Searcher Profile)

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