Over the years I’ve seen a variety of bonus and incentive plans for startup executives. Ideally, equity compensation alone would drive the appropriate behaviors to optimize what’s best for the business but bonuses and incentive compensation are commonplace as the startup scales.
In the early years, below a few million in revenue, it typically doesn’t make sense for an executive bonus plan as the business doesn’t have enough repeatability, there are few executives, and it isn’t worth the overhead. With time and success, a bonus plan should be added.
There are a few guidelines I like to think through for a startup executive bonus plan:
- Keep it Simple
Too often, I see plans that are overly complex. The main goal of the bonus plan is to drive behavior that aligns with the business goals. Multiple priorities equals no priorities. For an initial plan, err on the side of being too simple and go from there.
- Target the Most Important Metrics
While there are dozens of metrics that should be tracked weekly, it’s best that a bonus plan align with 1-3 metrics that are both easy to understand and the most important in the business. For example with SaaS, growth rate is a huge driver of valuation and is a common bonus metric.
- Counterbalance the Metrics
Ideally, one or more of the bonus metrics have a counterbalance metric so that the combined results are best for the business. As an example, if growth rate is the first metric, the second metric would be cash burn such that the executives are aligned to grow as fast as possible while burning an appropriate amount of cash. Faster growth might be possible with more cash burn, but the executives would be incentivized to get the mix just right for their bonuses, and this would align with the board expectations.
- Tied to Base Salary
Bonuses are usually connected to the salary as a percentage of base compensation. For example, a bonus that is 30-40% of base salary is most common so that executives have the majority of their short-term compensation paid out regularly and once a year they get their bonus (typically paid out after the fiscal year is closed out).
So, as an example, an executive bonus plan would be 40% of base salary and weighted with 70% for growth rate and 30% for cash burn and paid out annually. The percentages and metrics vary from business to business but the general ideas stay the same: keep it simple, target the most important metrics, counterbalance the metrics, and tie it to the base salary.