If you are a business owner looking to reward loyal staff and align incentives, but not ready to part with equity, a profit-sharing arrangement might be the answer.
Used wisely, profit sharing can:
- Encourage performance and accountability;
- Help retain key employees; and
- Recognise contribution in a tangible way,
all while allowing you to maintain complete ownership and control.
However, not all profit sharing models are created equal, and the wrong structure can create confusion, cost, and culture problems.
What is profit sharing?
Profit sharing involves distributing part of your business’s ‘profits’ to employees without giving them shares or formal ownership rights. It creates a sense of participation and shared success, while keeping governance and equity decisions firmly in your hands.
Common profit sharing models (without equity)
If you do not wish to give your employees equity in your business, but still want them to share in the success of your business, here are some common profit-sharing models:
Discretionary Bonus Pool
A percentage of annual profit (e.g. 10%) is allocated to a bonus pool. How it’s divided, by performance, seniority, or contribution, is up to you.
Some discretionary schemes retain a discretion as to how much goes into the pool each year, while others entrench a given proportion of the profit to go into the pool, with discretion only as to how it is shared.
Good for: Smaller teams, or early-stage businesses needing maximum flexibility.
Formula-Based Plans
This is a more structured approach. For example, 5% of EBIT over a certain threshold is shared among eligible staff, using a formula (such as relative salaries, performance benchmarks, or fixed points).
Good for: Businesses with consistent profitability that want predictability and transparency.
Phantom Equity or Shadow Units
Employees are allocated ‘fixed entitlements’ that track the company’s value or profit, without issuing actual shares. They may receive annual distributions or payouts on a trigger event like a sale or retirement.
Good for: Key staff whose long-term performance you want to incentivise and align with the company’s value, without altering company structure.
Employee Bonus Trusts
A trust receives a share of business profits and distributes bonuses to employees, often in a tax-effective manner.
Good for: Larger businesses or those with tax structuring in mind.
Deferred Profit Sharing
Profits are allocated now but paid later, such as upon retirement, sale, or over a progressive vesting period.
Good for: Businesses wanting to promote long-term retention without immediate cash outflow.
Revenue vs Profit-Based Sharing
Some businesses prefer to link bonuses to revenue (simpler and more predictable), while others use net profit (which accounts for expenses but is more variable).
Tip: Be cautious! Profit-based models are fairer but can be misunderstood unless clearly explained.
Call us on 1300 654 590 or email us for tailored advice on which profit sharing models are most suitable for your business.
Areas of caution
While profit-sharing can be a powerful incentive, it isn’t without risks. Poorly structured or communicated arrangements can create confusion, financial strain, or even legal disputes.
Before rolling out a plan, it’s essential to understand the potential pitfalls,both operational and cultural, and ensure the model is aligned with your business’s capabilities and goals.
Some considerations for business owners:
Define ‘Profit’ Clearly: Is it net profit after tax, EBIT, or something else? Be specific in your documentation. A key area for dispute is non-arm’s length or ‘private’ expenses met on behalf of the owners. Employees may soon take a keen interest in this type of expenditure if it may affect profit calculations.
Avoid Entitlement Culture: Even if payments occur regularly, make it clear that profit-sharing is conditional and not guaranteed. Employees tend to view anything money related as a fixed right, and not subject to any risk or downside variation.
Cash vs Paper Profit: Profits on paper don’t always equal cash in the bank. Include the ability to build reserves or defer payments. A generous profit-based bonus scheme can absorb cash that may otherwise have been earmarked for capital investment.
Administrative Complexity: Accurate profit calculations, tracking eligibility, and ensuring PAYG and superannuation compliance can add administrative workload. Make your scheme rules simple to understand and apply in practice.
Legal Documentation: Unclear or informal arrangements risk being seen as enforceable promises. Use agreements that spell out: eligibility and performance criteria, profit calculation method, timing of distributions, discretion to amend/pause/cancel, confidentiality and dispute resolution. This is one area where clear documentation avoids costs.
Employee Understanding: Be upfront about the risks, thresholds, and caps. Variability in profit may mean some years have reduced or no payouts.
Case studies: how you might do it
There’s no one-size-fits-all model for profit sharing, how it works in practice depends on the size of the business, its cash flow, culture, and goals. The following case studies illustrate a range of approaches business owners might take to reward staff without giving away equity. Each example highlights practical insights, benefits, and common challenges
Case Study: A National Retail Business implemented a quarterly profit-sharing plan for store managers, tied to individual store EBIT. Managers were more engaged, and store profitability improved. The plan was paused during trading downturns, highlighting the importance of reserve policies and flexibility. Disputes arose from time to time as to the allocation of head office expenses to each store.
Case Study: A Professional Services Firm gave senior associates phantom units tracking firm revenue growth. Units vested over time and paid out on retirement or sale, encouraging long-term commitment without affecting equity. As the cost of junior staff increased relative to charge-out rates, the cost of the scheme ate up a greater share of overall profits.
Case Study: A Regional Manufacturing Company used a simple annual bonus pool linked to net profit. The team culture improved and staff turnover dropped. However, payouts dipped in slow years, reinforcing the need for proactive communication. From time-to-time participants complained about the cost of the managing director’s interstate travel, believing that his business class airfares and 5-star accommodation were eating into ‘their’ net profit.
Case Study: A Mid-sized Engineering Firm allocated a percentage of profits annually into a deferred pool, payable after three years of continued employment. This incentivised staff retention without immediate cash impact. However, initially the documentation of the scheme was not clear, and several disputes arose with terminated employees as to ‘cashing out’ their accrued entitlements.
By way of example:
A manufacturing business adopts the following profit-sharing model:
- Profit threshold: Net profit must exceed $200,000 per annum
- Profit pool: 7% of net profit above the threshold
- Eligibility: Permanent staff employed for 12+ months at the commencement of the year period
If annual profit is $300,000:
- Pool = 7% of $100,000 = $7,000
- Divided equally among 7 eligible employees = $1,000 each
This kind of simple calculation gives clarity and transparency.
Should you offer profit sharing?
Profit sharing can be a valuable tool, but it’s not right for every business. Before you implement a scheme, it’s worth taking a step back to consider your objectives, financial consistency, and appetite for ongoing management.
Asking the right questions early can help you decide whether profit sharing aligns with your long-term strategy and workplace culture. Ask yourself:
- Do I want to share the upside without sharing the risk?
- How will I decide who participates and to what extent?
- Are my profits consistent and measurable?
- Can I explain and document the profit basis clearly?
- Am I willing to review and adjust the plan over time?
- What additional financial information will I need to give the participants?
If so, a tailored profit-sharing model could lift performance, build loyalty, and support succession planning.
How we can help
Profit-sharing arrangements sit at the intersection of employment law, tax planning, and strategic business design. At ADLV Law, we help business owners craft legally sound, flexible plans that reward employees and protect long-term control.
Call us on 1300 654 590 or email us to discuss how a tailored profit-sharing arrangement could work in your business.
The information contained in this post is current at the date of editing – 04 August 2025.
