470: Revenue Sharing Models for Startups

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Steli Efti: Hey everybody, this is Steli Efti …

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Hiten Shah: And this is Hiten Shah.

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Steli Efti: And today on The Startup Chat we’ll talk a little bit about revenue share and profit share models for startups. So you are running a startup. Let’s say in this case it’s more likely that it is a self funded startup, right?

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Hiten Shah: Yeah.

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Steli Efti: It’s not very common in the VC world to raise venture capital and then to do revenue share with your employees, especially not in the early days. So you’re self funded, you get to some level of success and then you see this pop up more and more that employees of these well growing companies that are doing really well, are at some point probably asking themselves, okay, so I’m part of this startup but I’m not getting equity. We’re not raising money so we’re not going to IPO or anything like that. So how do I participate in the continuous success and growth of the startup beyond maybe my salary or something? And so I see more and more startups come out and share their profit sharing models or revenue sharing models. But I still feel like it’s a new thing, especially in the startup world. It’s not a super set, it’s not as common and there’s not as many best practices for this as for handing out equity and building and setting up option pools and all that kind of stuff. So just wanted to tap into that. Who would we advise to do this? How should people think about it? When is the right time? When is too early? When is it too late? And what are some successful models that are out there or some ways to think about this, or some mistakes to avoid?

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Hiten Shah: Yeah, I think one model I’ve heard of, it might be the Basecamp folks, it might be somebody else, was that basically, it’s a profit sharing based on the growth in profit.

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Steli Efti: Hmm.

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Hiten Shah: And so then, because a lot of things like this, when you’re sharing revenue, whether it’s commissioned for salespeople or sharing profit like in this- … Probably would be like the owners. So it would be owners of the company who have the majority of the shares or the majority of the equity in the company. And then the business, which is basically the thing that we’re all working on and then the team members. And so if you do it so that no matter what everybody gets profit regardless of whether the company grew or not, I think it can lead to some really weird incentives. And incentives where like the team members aren’t necessarily incentivized to grow it in the way they would be if their profit sharing was based on actually growing the business. It would even impact the owners in that way. Because if you go out like three or four years, the company’s flat and there’s profit sharing happening. Everyone’s getting money, but they’re not getting money because they’re making the business better. They’re just getting money because the business is still there.

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Steli Efti: Yeah.

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Hiten Shah: Which is different than the business getting better. So when I think about this, I don’t think about revenue share. I think about profit sharing and I do think about making it based on growing the business. So even if the business grew 5% and there was more profit, that’s great. And now think about it, even if the business … And if you really make it about profit then you could not grow revenue, but grow profit, and that would still be okay. Because then the team gets incentivized around, let’s make more profit. Let’s not worry about revenue as much as we worry about profit.

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Steli Efti: Profit, yeah.

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Hiten Shah: What’s it going to take to help us make more profit? And there’s two ways, right? You are more profitable from a percentage basis margin, things like that, or you’ve grown the business.

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Steli Efti: I love that. I love the model of using both because the profit sharing thing has always struck me as curious because of these very reasons. I’m like, if a startup does profit sharing in a phase where the company’s still trying to grow really fast, isn’t this focusing everybody on increasing profit margins versus increasing growth? Isn’t it also that it might’ve been better for the business to use the profit to build out, maybe a cash cushion or do some other investments in the business. And now instead of doing that, we’re just instantly paying out a huge chunk of profits that are there because we incentivize to want to pocket all these, everybody that works in the business. Versus if there’s some kind of a bonus structure based on revenue growth, then that’s much more aligned. But I love the combination within the two. What about a phase? Is there a phase where this is too early? And I think I would tell people when they’re just starting out, it’s probably not a good idea to build an elaborate revenue profit sharing model if you don’t have revenue or profits. But what typically would you advise, when is a good time for a founder or [inaudible] to worry about this, what do you think?

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Hiten Shah: Well, my opinion is when you believe that the company is stable and has a repeatable ability to make money. Even if it’s not initially growing yet, it’s a repeatable way to make money and there’s actually enough profit there to go around. So you could say it’s when there’s 100K a year profit or when there’s like 250K a year profit, but when there’s a significant enough amount of profit that there’s enough to go around. That would be my take.

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Steli Efti: I love that. Yeah. Any other things that you’ve seen? We’re talking about self funded startups and so one of the big tools that … And maybe they decide to still do this, but a lot of self funded startups they’re not as heavy on the equity side of things and option pools and all that as the VC funded side of things.

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Hiten Shah: It doesn’t make sense. It doesn’t necessarily make sense for a self funded company.

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Steli Efti: Yes, so if you take off the equity as a form of compensation off the table, then obviously there’s salary, there’s quality of life, there’s maybe other benefits that you’re paying, but profits and revenue or cashflow profits, maybe that’s more abundantly available than in a venture funded startup is. So that’s obviously a pull to get to. Have you seen any other models of things that self-funded startups do to incentivize their employees to, you know basically-

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Hiten Shah: I think-

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Steli Efti: but-

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Hiten Shah: I think there’s the classic bonuses. It’s classic, right? I don’t hear enough about that, but you can give out pretty healthy bonuses based on certain metrics about the business. What’s wrong with that?

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Steli Efti: Nothing.

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Hiten Shah: Right, that’s like a cash basis. You could base it on performance of the business. You could base it on revenue, not profits and make sure people have a healthy bonus. So the reason I like something where it’s profit sharing type thing is because you can imagine someone who’s making a 100K or 120K or 80K, whatever a year, end up making an extra 10, 20, 30, even 50K on top because of the success that the business have had. And that actually increases retention with folks and things like that, because at some point there’s no other way that they can make that kind of money, especially if the business continues to grow and they’re contributing part of it. I think, there’s actually a book on basically some of this stuff. I forgot the name of the book, so I’m sorry, you’re going to have to dig around for it. I don’t know the name. But after [crosstalk 00:07:56]-

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Steli Efti: [crosstalk] Tweet us.

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Hiten Shah: Yeah, it talks about a tire company that basically has a pretty solid way of thinking about profit sharing and all that. I believe some folks in the company became millionaires because of the profit sharing. I could be wrong, but the folks who are incentivized appropriately in the company in that way ended up getting a huge benefit. And so giving team members that benefit I think is another thing, and part of it. And also there’s a system of, the longer you’re there, the more that you get and things like that. So there’s a system and it can work. It’s just a matter of being really thoughtful about it and studying up a little bit. I do think that the Basecamp folks have the model that’s based on percentage of growth in terms of profit, but I could be wrong. And they are actually a pretty good starting point for this, if you’re thinking about doing this. And then I know there’s other examples but I actually studied this a little while ago and I felt like they had the most thoughtful model and most thought out model around doing this. Especially because they are a highly profitable business that has had to figure this out.

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Steli Efti: Love it. All right, so I think that if your a self-funded startup, it might make sense to look into this as you probably don’t want to do this too early when you’re still trying to figure out how to acquire your first hundred paying customers. Putting together an elaborate revenue or profit sharing model might feel like meaningful work, but most likely it’s just a waste of your time and everybody else’s time to focus on these things. But once you are at a point where you have repeatable revenue, you have some predictability in terms of your growth, you have a “real business” right? It’s not just an idea. It’s not just a wild project, but it’s a thing that is thriving and growing and generating cash flows and profits and revenues. It might make sense to start spending some time and think about this and putting some thing in place to really empower everybody that’s investing and contributing to the growth and the success of the business, to participate in that growth in some meaningful way. If you have any great examples, great books, if you’ve tried things and failed with them or succeeded with them, we always love to hear from you. Just shoot us an email at steli@close.com or hnshah@gmail.com and until next time, we’ll hear you very soon.

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Hiten Shah: See ya.

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