A Brief Introduction of Profit Sharing Agreement
We often come across cases in which employers decide to share some percentage of their yearly profit with their employees. It can be seen as compensation beyond employees’ salaries and bonuses. Companies introduce such plans to share the profit with the workers; these plans are also called incentive plans.
When employer and employee get into a Profit Sharing Agreement, they specify how the profits will be divided, and what would be the timeline. Sometimes the profit-sharing can be in cash, and sometimes it can be in terms of stocks or bonds — the mode of profit sharing and how it gets calculated to vary from company to company.
However, Profit Sharing Agreements can also be signed between the two businesses, two business partners, or two individuals.
Companies can also have a Profit Sharing Plan that allows them to help employees save for retirement. In such situations, companies are well within their rights to decide how, when, and how much should be contributed to an employee’s plan. Profit-Sharing Plan or Profit-Sharing is subjected to the amount of profit gained. These are flexible modes of revenue.
Who Takes the Profit Sharing Agreement – People Involved
Companies or businesses today want to give their employees as many perks as they can to keep employees happy and satisfied. Beyond regular salary and bonuses, if employers can create a revenue policy or profit-sharing plan, then it becomes relatively easy for them to retain the employees. A Profit Sharing Agreement plays a huge role in specifying the terms and conditions of a profit plan. It gets signed between the employee and employer. Other people who can take the agreement are two business partners, two businesses, etc.
Purpose of the Profit Sharing Agreement – Why Do You Need It?
When the employers decide that they want to share a certain portion of the profit made by the company with employees who have contributed to such success, they also need to specify the ratio or formula that they will use to decide the amount. At the same time, if a company doesn’t make any profit at all, corporations will have to specify that there will be no profit sharing in such a scenario. Profit-Sharing Agreement becomes paramount to put such details in writing.
It should be noted that it is solely a company’s prerogative to decide who should receive profit from them. In most cases, companies only choose certain deserving people to share the profit with.
Similarly, two business partners will also always need a Profit Sharing Agreement to express the ratio they will use to divide any profits or losses. In such a case, it also depends on how much each partner has invested in the business.
Once the promise of Profit-Sharing is made, it is important to document the details of it in a contract to avoid any future conflicts and confusion. It is the responsibility of the involved parties to draft the agreement with clarity and precision.
Before signing the Profit Sharing Agreement, all parties must agree on the ratio rules and sign the contract.
Contents of the Profit Sharing Agreement – Inclusion
Profit-Sharing Agreement must include the basic details of the parties involved. Their names, addresses, their role in the company in case of employee-employer profit sharing, their phone numbers, etc. are a few basic details that must be added.
Further, in a very comprehensible way, the agreement must include how the profit will be calculated for each individual and how it will be shared. Profit can be shared in cash, stock, or bonds. Companies have their own ways of deciding which model they want to use. It is a company’s responsibility to mention all such details in the agreement.
The timelines of when the profit will be shared should also be expressed in the agreement. Employers should always add a clause which categorically mentions that in the absence of profit made by the company, the employees won’t receive any profit.
Here are the inclusions of the Profit Sharing Agreement in pointers –
- Basic details of all the parties involved
- Profit-sharing ratio or formula
- Any other details about how the profit will be calculated
- Timing of the profit delivery
- Time-period that will be considered for calculating profit (Most companies do this annually)
- Important clauses
- Details of any exceptional cases
- Details of taxes
- Details of any crucial conditions that may apply
Most Profit Sharing Agreements will have these crucial inclusions; however, in the case of Partnership Profit, there will be more inclusions and details about how the losses will be divided, etc.
How to Draft the Profit Sharing Agreement?
Profit-Sharing contribution from employers requires a huge amount of administrative work and caution. Once the employers make such promises, it must be followed diligently to maintain the trust of the employees and to avoid any breach.
As discussed above, there can be two ways in which a company can share profit. One is Retirement Plan Deferrals (also referred to as Profit Sharing Plan), and another is Profit Sharing as Base Compensation. In the first one, a portion of employee’s profits goes into a retirement account like a 401K in which employees can make their own contribution too or a qualified tax-deferred retirement account. In this case, employees also get to take this profit with them when they leave the organization. But in the second case, employees can’t take their share with them when they leave before profits are distributed.
These are a few very important details that should be discussed between the employer and employees before drafting and signing the agreement. The employer must make the draft in a simple language so that the employees understand the conditions and terms.
Negotiation Strategy
In Profit Sharing, employees can decide how they want to divide the profit and to whom. There is not much scope for negotiations. However, some employees can talk to their seniors and manager and request to include them in the profit plan. It also depends on the kind of contribution a particular employee holds in the company.
Benefits & Drawbacks of the Profit Sharing Agreement
Here are some very important benefits of the Profit Sharing Agreement –
- Performance enhance as employees are likely to be more motivated
- Ensures employees that their good performance, dedication or contribution to the company will benefit them
- Employees would want to work together as a team to take the company forward and to make it profitable
- Conditions the employers to pay the profit share only when the profit is made
- Helps in the overall growth of the company
- Helps the company in retaining its dedicated employees
Here are some of the drawbacks of the Profit Sharing Agreement –
- Profits can be fluctuating
- Employees’ dependence on the profit
- Employers have to keep the employees informed about the company’s profits, losses, and finances
- Can create unnecessary pressure
- Can become a cause of conflicts amongst the employees and management
What Happens in Case of Violation?
One of the key purposes of signing any agreement is that it gives you easy access to legal remedies in case of any breach or violation. Similarly, in the case of the Profit Sharing Agreement, if one party (or the employer) doesn’t release promised profit, then the other party is well within its rights to take legal help. However, between employees and employers, if the employers don’t release the profit share, employees tend to negotiate and use personal relationships over the legal battle. A verbal engagement helps a lot in such cases(1).
Because of the many pros and cons of profit-sharing, companies should be extremely cautious while planning it out. Companies are also advised to do a cost-benefit analysis before deciding to implement profit-sharing and drafting agreements for it.
As we have discussed previously, when profit-sharing is implemented properly, companies can benefit from it, and employees can also be kept happy, which leads to the overall success of the company. But, at the same time, it can also cause trouble for the trouble if not implemented with a well-thought-out plan.
Profit-sharing requires a lot of paperwork, too, so the company has to devote its administration or HR department to this. Overall, it’s a healthy way for companies to grow and make profits. With little care and caution, companies can implement it diligently.