“Show me the incentive and I will show you the outcome.”
This is the free version of Trends PRO #0035 — Profit Sharing
- Profit sharing is about capital allocation.
- Profit sharing is a short-term incentive.
- Profit sharing may lead to moral hazard.
You have profits.
Ok… What’s the problem?
Investing in growth and development has diminishing returns.
Profit-sharing plans give employees a percentage of profits.
- Private equity firms will buy profit-sharing companies, cancel plans and reinvest in, or buy more, portfolio companies. See WestView Capital Markets.
- Income pooling will become popular in high-risk fields. Think MLB and VC-backed founders. See FounderPool and Pando Pooling.
- Consider the opportunity cost of capital before profit sharing. Should you distribute profits? Or reinvest in growth and development? (via Prasanna)
- Use equity to align long-term incentives. Profit sharing (alone) aligns short-term interests. Short and long-term incentives can conflict.
- Manage expectations. Make it clear that the percentage (or existence) of profit-sharing plans may change. See Basecamp’s handbook.
- Consider taxes. Deferred compensation can delay taxable events. Mailchimp’s profit-sharing plan adds up to 19% of your salary to a 401k plan. As the press release states, “…that’s good shit.”
🔑 Key Lessons
- Profit sharing is a short-term incentive. And nudges teams to put short-term profits above long-term value.
- Know your north star. Sometimes profit isn’t the goal. Maybe it’s growth. In which case, profit sharing may be a bad idea.
“Profit sharing leads to moral hazard?!”
Done without equity. Yes, it can.
“If I don’t plan to sell. Why should I give up equity?”
To align long-term interests. See why Nathan Barry changed his mind.
“Reinvesting in growth and development is greedy.”
You can reinvest profits and issue equity or options.
“Employees that don’t take early risks should not get equity.”
Do you want to be right or effective? The amount can be risk-adjusted. Do you need engineers and product managers to think long-term?
“What about intrinsic motivation?”
That’s table stakes. We’re talking about profit sharing.
“What about short-term projects?”
Short engagements have faster feedback loops. Profit sharing may be fine. But even salespeople have clawbacks.
“What if I want to reward my team in the near-term?”
Dividends can be tied to equity or phantom stock.
“So what? Should I not share profits without equity?”
Do you want employees to sacrifice long-term value for short-term gains? Basecamp doesn’t give equity but tries to mimic equity with a liquidity pool.
“What if roles are derisked? Or systematized?”
Fair. What type of talent do you need to attract?
- Who does profit sharing? • The tweet behind this report.
- Profit Sharing w/ Nathan Barry • ConvertKit ditched individual performance in their profit-sharing plan.
- Maximizing Profits by Investing in Your People • LetterLogic used profit sharing to shape culture.