Until recently I thought profit sharing was one of the best ways to compensate employees.

Profit sharing has the following advantages:

* Links employee compensation to company performance * Is usually far more realistic than share options * Presents a relatively low risk to the company

The big problem with profit sharing is that it takes capital out of a company. This could be money that the company could use to grow. Paying out this money is not only bad for the company but could also be bad fro the employee.

A company growing in value at a rate of 20% or greater represents a much better rate of growth than most other investments. Anyway I'd rather invest in the company I work for than some other company I know less about (I think there's something wrong if you _don't_ want to invest in the company you work for).

Assuming the company is not publically traded and has no ambitions to be how do you find a balance between keeping the money in the company and allowing employees to share in the company's success?

Simon.

-- Anonymous, March 26, 2001

Answers

Well, the answer to me is that contributing to your employees welfare, belief in the mission of the company. and making them an integral part of your company's success IS keeping the money in the company. Isn't that the best investment you can make? In your employees? After all, in software your product really is an extension of your people.

Then again, I don't always think profit sharing is the only way to do that. Spending the money on the little things to make your company a great place to do great work is probably the best investment you can make. Having to pay people extra in the form of cash incentives probably indicates that something is wrong with the day-to-day environment.

Rather than profit sharing, I advocate a better day-to-day environment - free access to supplies (where I'm sitting right now I couldn't get a pen if I wanted one...and right now I need one), easy access to training materials, frequent team activities, food at long working lunch meetings, all those little things.

Give people the opportunity to do their best work in a rewarding environment and you're directly investing in your own people. Shouldn't need cash incentives at that point, hopefully. If you do need to reward your people with checks, then profit-sharing is a good way to make them sit up and pay attention to the big picture that most of us don't care so much for.

-- Anonymous, March 26, 2001

investing in employees

What if you pay your employees more than enough to cover their ordinary living costs. Then you give them a lump sum from the profit sharing.

If I was said employee I would now need to invest this money to earn a decent rate of return on it. I can go out and buy Cisco shares (decently priced for the first time in years) but as an employee of a company I know is going to get a great return on capital I would rather invest this lump sum in the company I work for*.

How do you do that if the company is private?

* Also if the money doesn't come out of the company in the first place you don't have to pay tax on it. 30% tax defferred until the end of say 10 years on money which is growing at 20% compounded/year adds up to a shedload.

-- Anonymous, March 28, 2001

The big problem with profit sharing is that it takes capital out of a company.

That's the big problem with paying salaries, too.

-- Anonymous, March 26, 2001

Ja well

If only one could eliminate those!!

Salaries are necessary, profit sharing is not. The point is profit sharing/share options allow employees to share exceptional company performance. The salaries should already give them a comfortable lifestyle this is cream.

Warren Buffet prefers not to invest in companies which don't pay dividends as he feels the money is better spent in expanding the company. There must be a way to do this internally also.

-- Anonymous, March 28, 2001

Warren Buffet

That should have been -> "Warren Buffet prefers to invest in companies which don't pay dividends as he feels the money is better spent in expanding the company."

Looking at what works from an investment perspective can be quite informative when running a company.

-- Anonymous, March 28, 2001

Looking at what works from an investment perspective can also balls up a company completely. Many, perhaps most, of the dot com disasters are wholly and soly a result of companies being driven by their VC investors only interested in the exit strategy and returns thereon.

Which is their prerogative, of course, but it doesn't necessarily leave one with a viable company at the end of it.

(Memo to self: never accept VC when there is any alternative whatsoever. Selling own body to Russian sailors to raise capital may be less painful).

-- Anonymous, April 02, 2001

Well I'm a long term buy & hold investor. I'm talking long term sustainable not get-in get out investing. What works. VCs are playing a different game to investors.

-- Anonymous, April 03, 2001

"but as an employee of a company I know is going to get a great return on capital I would rather invest this lump sum in the company I work for"

Uhh, this is an extremely stupid thing to do. Because, when the company goes into the toilet, not only are you laid off, but your nest egg is worthless. Just about every personal finance & investing guide strongly suggests that you make sure your portfolio is diversified and not heavily invested in your employer's stock.

Lots of companies have found a great way to keep demand for their stock up by having the default option for 401K-style programs be "buy company stock"... this is great for the firm but a bad deal for employees.

-- Anonymous, April 03, 2001

Gabriel,

Warren Buffet says that the reason for people diversifying portfolios is in order to protect themselves from their own stupidity. Spreading your money among a number of companies which you don't know a lot about probably mean you'll lose less when the surprises come. But if you don't trust your own investment judgement why invest at all - does somebody else care more about your money than you?

As for the point about your investments going down along with your company, this may be true if you don't know much about the company you work for. I'm in the position where I have a good idea of the prospects of my employer. When my previous employer refused to answer my questions about margins and profitability ("that's not in your job description!")I started looking for another job.

What one does should have a significant bearing on the sucess of the company. If employees think like owners the company is more sucessful. What I want to know is how to accomplish this without taking the company public.

Simon

-- Anonymous, April 04, 2001

pranshu,

First, there are lots of non-public corporations which are held by employees. Edward Jones is one.

Second, another way to look at profit sharing is that they are giving up pay in poor years for the hope of better compensation in good years.

Is the question that you are pondering, how do you align the interests of an employee to that of a company? And are there restrictions like not wanting to make them full shareholders?

Chris

-- Anonymous, April 04, 2001

Hi Chris,

This is not something the company where I work is presently dealing with - but it someday may (we are a privately held software development company of 50 staff). It is something I am enjoying thinking about.

There's no problem with employees being full shareholders. I want a streucture where: * The employee shares in the profits of the company * The employee can invest these profits back into the company should she wish. (presumably they will if they see the company being sucessful) [1] * The employee if necessary can easily realise the capital he has invested in the company ("going trekking in India, please feed cat & sell share of company") * Management have the lesuire to plan delivery for the long term (the market forces many public companies managers to focus on the short term)

I'm not sure that Edward Jones meets these criteria. I had a brief look at the website but didn't find out much about the ownership structure. Is it a mutual company?

pranshu.

[1]My favourite example of this is Steve Ballmer borrowing every cent he could to buy microsoft stock.

-- Anonymous, April 05, 2001

Ah. So it's not a specific case you're thinking about so much as a general just thinking thing. Ok.

Edward Jones is not publicly traded, but owner by employees. Edward Jones occasionaly offers it's associates (employees) the right to purchase a share of the company. The first opportunity is at about 2 years (assuming good annual reviews) if you buy those shares you are no longer a mere employee, you are also an owner. They also have performance bonuses.

I'm not sure if this fits your model exactly but I don't know if any existing model does. I don't see how you can have the employees share in the profits without removing capital from the company. The best you can do is delay the capital from being removed from the company (and you will probably have to offer incentive to do this).

Chris

-- Anonymous, April 05, 2001

I will make a slight leap of faith and assume that you started with the premise that you think profit sharing is a good way to compensate employees (what you said) because it motivates people to work better/harder for the company (what I think is implied in that statement). Granted it is employer-centric (as opposed to employee- centric) definition of "goodness" but you can turn around and say that what's good for the company is ultimately good for the employer.

Given that assumption, according to the book (a href="http://www.amazon.com/exec/obidos/ASIN/0071351450/">"Bringing out the best in people" this is not a very good to compensate if your goal is to improve employees performance. There is no way I can summarize this (very good) book in a few lines (so I suggest reading it yourself) but the main argument is that profit sharing doesn't really tie your every day performance (at that's what ultimately matters) with the benefits you receive (your shares in the company). In other words: the fact that you own shares in your company doesn't really motivate you to work better/harder on a daily basis. The same problem exists with performance bonuses: a vision of (possible) bonus 6 months away is not enough to make you work better today. According to the book (I happen to agree).

You can also read Greenspun's (controversial to some) article on Managing software engineers.

-- Anonymous, April 21, 2001

Hi Yon,

I'll check out the book - thanks!

You say, "In other words: the fact that you own shares in your company doesn't really motivate you to work better/harder on a daily basis.". Huh!?

This is clearly not true if you own 80% of the company, or probably even 10%. At what %age break point do you think your statement becomes true? Is this not perhaps a problem of education? Perhaps employees don't understand what it means to be an owners as they never have been owners.

Do these statements sound familiar:

• "Choose the best resturant, don't worry about the cost I'll put it on my expense account"
• "It's a company car"

Small business owners don't do this, they treat the company's finances as they would their own.

best, Simon

-- Anonymous, April 27, 2001