Profit Share / Stock Options

How does Profit sharing work? 
The company contributes a portion of its pre-tax profits to a pool that will be distributed among eligible employees. The amount distributed to each employee may be weighted by the employee's base salary so that employees with higher base salaries receive a slightly higher amount of the shared pool of profits. Generally this is done on an annual basis.

• Brings groups of employees to work together toward a common goal (the success/benefit of the company).
• Helps employees focus on profitability.
• The costs of implementing the plan rise and fall with the company's revenues.
• Enhances commitment to organizational goals.

• The pay for each employee moves up or down together (no individual differences for merit or performance).
• Focuses only on the goal of profitability (which may be at the expense of quality).
• For smaller companies, these plans may result in drastic swings in earnings for employees which the employees may find difficult to manage their personal finances.
• Adherence to the FLSA requires employers to recalculate each worker's "regular rate" of pay. To overcome this limitation, employers may restrict this type of compensation to exempt employees.

1. Incentive stock options (ISOs) in which the employee is able to defer taxation until the shares bought with the option are sold. The company does not receive a tax deduction for this type of option.
2. Nonqualified stock options (NSOs) in which the employee must pay infome tax on the 'spread' between the value of the stock and the amount paid for the option. The company may receive a tax deduction on the 'spread'.

How do Stock options work? 
An option is created that specifies that the owner of the option may 'exercise' the 'right' to purchase a company’s stock at a certain price (the 'grant' price) by a certain (expiration) date in the future. Usually the price of the option (the 'grant' price) is set to the market price of the stock at the time the option was sold. If the underlying stock increases in value, the option becomes more valuable. If the underlying stock decreases below the 'grant' price or stays the same in value as the 'grant' price, then the option becomes worthless.

They provide employees the right, but not the obligation, to purchase shares of their employer's stock at a certain price for a certain period of time. Options are usually granted at the current market price of the stock and last for up to 10 years. To encourage employees to stick around and help the company grow, options typically carry a four to five year vesting period, but each company sets its own parameters.

• Allows a company to share ownership with the employees.
• Used to align the interests of the employees with those of the company

• In a down market, because they quickly become valueless
• Dilution of ownership
• overstatement of operating income

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