What Do We Do with Our Profits?

May 27, 2002

Jose Piranha listened to his two partners, Stephanie Straighthair and Jason Loseria, discuss how to dole out the firm’s profits in the coming year. They were sitting at their favorite table at Hugo’s, the little downtown basement bar and restaurant that was located in the same block as the offices of their firm, PSL & Associates. The company had just come off a record year— 20% growth and 20% profits— fantastic. And while they paid out record bonuses to everyone, owners and employees alike, they weren’t totally happy with the way things went. The hourly people thought the salaried people got more than they did. The salaried people felt that the hourly people had already gotten their “bonuses” through their paid overtime. Straighthair felt that too much went out to the employees and that the owners should have gotten more than they did. Loseria felt the employees should have gotten more and that they, as the owners, were too greedy. Some of the associates wanted to create a special bonus pool based on the performance of their studios or departments. And some people just thought that others got too much and that they didn’t get enough. Let’s see if we can’t learn something from listening in on their discussion and some of the decisions they made. “You just can’t keep everyone happy,” said Straighthair. The others agreed. But the importance of keeping the best people, the ones that they really couldn’t do without, was also something they agreed to. And they agreed that they didn’t want to create barriers to cooperation between one studio and another because that’s the way their former company operated. Yet creating the wrong incentive plan could recreate that situation. “Let’s decide where the money will go before the year starts,” said Piranha. It always annoyed him when they didn’t think strategically and reacted to their collective instincts at the time or the advice of their accountant, Tim Smallmind. They needed a clear plan that allocated profit dollars to retained earnings, owners, and the rest of the employees— and they should stick to it throughout the year. “How much do we need to retain for stock buy-backs and to finance the cash flow that our growth plans call for?” asked Loseria. The others thought that was a good question and a good place to start. They went right to their business plan and used the 20% growth forecast as input for some modeling that showed them they needed to keep 31 cents of every dollar earned in order to not become more dependent on borrowing. And that analysis assumed no stock buy-backs from any of the big three in the coming year. “How much should go to owners versus the rest of the employees?” was the question posed by Straighthair. It was especially relevant because the year after next they planned to start an ownership transition plan. One of the elements of that plan included using profit dollars as a means for employees to purchase the stock. If the profit allocation to owners wasn’t high enough, the profit distributions to owners wouldn’t help much on the stock payments. They settled on 44 cents of every profit dollar. “Should we be paying big bonuses to the hourly staff that earn time-and-a-half for overtime when the salaried people regularly work 48 to 50 or more hours per week?” asked Loseria. While they knew they would have complaints, they decided to bite the bullet and not pay the hourly people. The salaried people essentially had all of their overtime hours at risk. If the company didn’t make anything, they would get nothing for it. On the other hand, the hourly people were compensated, no matter what. So that difference was explained to the staff when the new bonus plan was rolled out. “What about a special pool for the senior managers?” asked Piranha. They debated this topic at length. But in the end, their conclusion was if they did that, then they would be taking money away from the owner distributions. And they agreed that keeping those distributions high was essential to making the ownership transition plan work. This is an important topic that requires some quality discussion among the management of the firm. Originally published 5/27/2002.

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