Profit sharing

[piecewise]

I am paying a colleague to help me build a piece of software I thought up. I will be setting up an LLC to sell this software. I want to further compensate him (he's not expecting this) by creating a profit sharing plan. Do you have any experience or advice with how best to set this up? Should I give him a percentage of profit, myself a larger percentage, and leave a percentage to build into the business? Or should I pay myself a salary, and then given him a higher percentage (since my salary will decrease profits dramatically)? How should I go about structuring it?

Thanks!
Chris

[Fergal]

Hi Chris, welcome to Business Advice Forum and thanks for posting your business question.

Profit sharing is an excellent motivator. There is little that motivates stakeholders in a business more than the potential to earn a share of the profits.

Regarding your own share of the profits and your personal salary, this is up to you to decide what is best for you and best for your business and your decisions in this area shouldn't have a major impact on what you agree with your colleague.

One approach would be to discuss the idea with your colleague and ask him about the approach he would like best. He might give you ideas as to what he personally would find most motivating, that you hadn't thought of.

You need to think about how long the profit sharing arrangement will last. For example, will it be for one year, the duration of his employment with the business or the life time of the business?

Personally I would recommend a shorter time period. This would allow you to test whatever scheme you decide upon and then make changes in the future, if necessary. If you go for a longer term agreement you might find that your business changes and develops and that the agreement somehow stifles the future growth of the business.

You could put a simple arrangement in place such as 5% of profits for the first year and make it clear that you will revisit the deal at the end of the year with the objective of agreeing a new profit share agreement for the second year.

Another advantage of paying the profit share at the end of the year is that the expectation of an end of year bonus will motivate your colleague to stay with the business. He will be less likely to leave the business and start working for someone else, if he knows that this would result in the loss of a good bonus.

Something you need to be careful of is the Intellectual Property (IP) rights of the software developed. Your agreement with your colleague should specify that the IP of the software he develops is owned exclusively, either by you or the business.

Including this clause could save you a huge amount of trouble and expense in future years. If you do not include this type of IP ownership clause, your colleague could legally be entitled to a proportion of all future profits of the business, arising from his role in the software development.

Please post back to let us know the lines you are thinking along and we will post further suggestions.

[pendelton]

Setting up as an LLC, is a good idea, only if you are going to list him as a part owner on the paperwork, but, otherwise, a one person LLC is called a disregarded entity.
Unless you choose the option to be treated as a corporation, in which case, you may as well file as a corporation and avoid the mess.
A single owner LLC also does not really have the asset protection that a straight filed corporation would have.
Setting up an LLC with his name on it may not be a good thing, since he may not want to be a part owner of the company, meaning you would be stuck that way.

Giving him a percent of the company is not a major issue, and, will later make the programmer more receptive to updating the application, unless, you have it all in the contract.

I'd suggest that you set up as a corporation and issue him special stock that can not be transferred except back to the company, this can voting or non voting stock. This would avoid a lot of issues in the future.

[Hurbel2k]

Make a business plan and think about how many units You will sell in the best case and worst case. Don't forget that You don't get all the money the end user pays: There are taxes as well, which will reduce Your profit. As You are the person who takes the highest risk, You should earn the most.

[chweet20]

Definition:

An arrangement in which an employer shares some of its profits with its employees. The compensation can be stocks, bonds, or cash, and can be immediate or deferred until retirement. Profit-sharing allows for changing contributions each year. Contributions are determined by a formula to allocate the overall contribution and distribution of accumulated funds after the retirement age. Unless the plans are defined as an elective deferral plan, the contributions are not tax deductible. Contributions and earnings can grow tax-deferred until withdrawal.