# How to share profit based on both effort and skill?

3

Suppose the following:

1. You have a very small startup (a few people) with almost no startup capital
2. You have a client or two and are making some money, but not enough to afford real salaries
3. Each member of your team performs a variety of tasks (development, testing, documentation, management, client relations), with highly varying amounts of effort (varying over time, and per teammate - I might work 20 hours this week but 5 the next, while my colleague might put in 10 hours one month, and then none the next)

Now given points 1 and 2 above, you decide that profit sharing as a form of payment seems reasonable for the time being. Because the amount of effort each team member puts into the project varies so much, you decide as a team to share the profit depending on the hours worked - the effort. A nice, simple formula.

Although this seemed fair at first, you soon discover a serious (and, in retrospect, obvious) problem:

• Although you're no-where near as good a programmer as your super-duper developer buddy, you each get rewarded the same for an hour's worth of work. In practice, this means that your super-duper developer colleague is (heavily) punished for being more efficient.
Your team quickly decides that you need a system that reflects both the effort put in and the teammate's individual skill levels. Being a huge proponent of transparency in the workplace, you come up with the following table, which is reviewed and updated as a team on a regular basis (eg: quarterly):
``````Dev Docs Management
You | 7 | 16 | 20
Super developer | 20 | 5 | --
Tech writer | -- | 20 | --
``` ```
Each number in the table is used as a multiplier to help calculate what share of the profit each teammate will get. Eg: If you work 2 hours of development and one of documentation, then you get 30 'profit points'. If your developer worked a single hour of development, and your tech writer didn't work this week, then they get 20 and 0 'profit points' respectively. That week, you would get 60% of the profits, and your developer would take 40%. Note that the hours are recorded usually once/week and 'roughly'.

The questions: Is this a reasonable, fair approach to splitting profit share under these circumstances? Is there a name for this sort of completely transparent table for how much everyone is 'worth'? Is there a much easier way to do this I'm missing?

Top digital marketing agency for SEO, content marketing, and PR: Demand Roll
• So are people working a variable number of hours on a weekly basis, or is it just that some people are always putting 60 hrs/wk while others are always putting in 10 hrs/wk? – rbwhitaker 12 years ago
• Great question, people are working a variable number of hours on a weekly basis - I might put in 20 this week, but only 5 the week after. I've updated the question to clarify this. – Daniel Gill 12 years ago

3

You are adding a lot of overhead and friction under the guise of "transparency". Work in a startup is so fluid and rapid, that having this kind of timecard management is an overkill. Hell, even at a \$15billion company this was veto'd as an overkill and the quantum of unit was changed from hours to days.

Secondly, you're adding a lot of bean counting by having people count hours. If someone works for 45 minutes but puts in an hour, what do you think is going to happen to the dynamics? Do you want them to worry about "what about that 15 minutes?". Do you want others to catch and punish such 15 minute violations?

It's a small startup. You should be able to value each person's worth right upfront and split the equity that way. To accommodate any errors in that judgment, you would introduce a vesting schedule.

On top of the above, you can have a bonus pool of options to award people who have gone above and beyond the initial expectations, more than the others. I'm skipping the salary section since you said cashflow won't permit it. But note that in the US the startup owners are liable for minimum wages i.e. even though you won't sue yourself, you (or other partners) can sue the remaining partners for minimum wage violation.

In terms of measuring the performance, I'd recommend moving from "hours worked" to "milestones accomplished". Set milestones that are needed for your startup, assign importance, distribute per skillset, track on weekly basis.

Don't over-complicate matters!

• The point you make about suing over minimum wage doesn't seem quite right to me. You might be right, but I was under the impression that people working at the founder level are not bound to minimum wage requirements. They're treated as shareholders instead of employees. This other question discusses it too: http://www.brightjourney.com/q/co-founders-employees-need-paid-minimum-wagerbwhitaker 12 years ago
• I agree, your approach is overkill. After a few months of working together, you should be able to tell who on average is contributing what, and how important each one is. If someone who is not contributing much suddenly starts contributing a lot (over weeks and months, not days), then issue more equity. – Alain Raynaud 12 years ago
• @AlainRaynaud : Founders are shareholders AND employees, but shareholders don't necessarily have to be employees. Even if your contract says "not an employee", it can be considered employment (by IRS, USCIS and courts) is it's a job per the job market. eg: Meeting for coffee with advisers isn't a 'job' but calling customers or writing code is a employable activity. I'm not a lawyer but I did hear this from a very reputed startup lawyer. – Sid 12 years ago
• @Sid Excellent points, thank you. Let me clarify a few things. First, no one is expected to count exactly the hours they worked - they are usually recorded once/week unless a lot of work (>~20 hrs) has been done. Second, if we were all working full time then yes, it'd be straightforward to calculate each's value. However, since the number of hours worked in any given week or month is highly variable, such an up-front approach seems impractical. Finally I would feel more comfortable with milestones if I was confident in our estimates, but I will look into it. – Daniel Gill 12 years ago
• @Sid You also raise some very good points about possible minimum wage violations. Mine is a Canadian corporation but I will certainly look into it ASAP. Thanks! – Daniel Gill 12 years ago

1

This seems problematic because those multipliers are going to change over time...

There are a few tools at your disposal:

• salary/bonuses
• profits/equity share

You can pay at a different rate to different people and also allocate money based on "left over profit".

You should consider those methods rather than a complex formula of hours and rates and the like.

• Yes indeed, those multipliers are going to change over time - I added a note to that effect in my question (thanks). However... won't the salary/bonuses also change over time, just in a less transparent manner? – Daniel Gill 12 years ago
• Salaries do not have to be opaque - they can also be transparent. There are more things to focus on - and the system you presented seems to me to be a lot of work and can be gamed. Time is not the best way to calculate value/worth. – Tim J 12 years ago
• You're quite right about the salaries, though given our small but growing revenue, fixed salaries are unrealistic at this point. I've raised [another question](http://www.brightjourney.com/q/decide-much-pay-investment-small-startup) about best practices when it comes to calculating value/worth in these small-startup-cirupstances. – Daniel Gill 12 years ago