Some Practical Advice on Executive Compensation at Startups - 17 Dec 2009

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December 17, 2009

Some Practical Advice on Executive Compensation at Startups

Because
it's that season (bonus season, not holiday season) I've been getting
questions about executive compensation from friends.  But today I got
an interesting question the answer I wanted to share here.  The
question was something along the lines of, "Well, I know the on-target bonus numbers I want to recommend, but how should I link pay to performance?"

Well, there are basically three ways you can link pay to performance (in startups):

1. Discretionary (i.e. it's up to the Board or CEO)


2. One or more financial metrics


3. Balanced scorecard

For very early stage startups (e.g. pre-revenue and maybe even
pre-product), I recommend a discretionary plan, particularly when
you're dealing with annual plans.  It is just too hard to see out 12+
months with any certainty to be able to pick meaningful metrics.
 What's more, there is probably little money in the company so to
promise cash payments based on metrics without knowing the ability to
pay is a bad idea.

As a company matures, it makes sense to introduce some certainty
into the pay for performance plan.  By this point, your sales team and
hopefully your head of sales are already on commission plans (or at
least partially so).  You probably have operating budgets for each
department.  If you're seeing somewhat predictable financial results
(even if they're not moving in a way you'd like them to!) and you have
the reporting in place (dashboards) to track them, then it makes sense
to introduce one or more financial metrics to your pay plan.  Make sure
you don't introduce metrics too early; for example, before you have a
robust financial reporting system/process in place.

And finally, once the business has achieved greater scale and size
(50+ people, $10MM+ revenue, etc.) then you can start to think about a
balanced scorecard approach to your pay plan.  A lot of ink (and
electrons) have been spilled defining a balanced score card, but the
way I think about it is that it includes some financial metrics as well
as other important non-financial metrics that can and must be tailored
to your firm.  If you have an important software release coming up,
that could be included.  Or perhaps you want to have internal
performance reviews or customer satisfaction included.  Whatever is
important to you business and for which you have a way to track, you
can include it.

Something to keep in mind, even in the case of a discretionary pay
plan, you want to have your plan documented, approved and shared with
the appropriate folks.  It should be concise and important terms should
be defined.  For example, if you're going to tie some pay to revenue,
then be very clear about what "revenue" means.  

Also, set up
quarterly reviews with each executive to talk about progress.  Set the
expectation up front that you'll do these reviews and you may mutually
agree to change the metrics or other bits of the plan.  You should
build flexibility into the system, but rarely if ever use it.

Anyway, below is a template for MBOs that I've used in the past with
some success.  It's by no means perfect and I'm sure there are other
templates out there (post in the comments here and I'll update with the
best).