first_imgSince we are on the topic of the CEO’s annual rhythm, let’s talk about senior management compensation. As software companies graduate from the startup to the expansion stage, their Boards of Directors need to start formalizing the setting of executive compensation. Here’s a basic framework.1. Formalize the process through Board-level accountabilityDuring the startup phase, software company founders are usually paying themselves what the company can afford and paying their employees as little as possible. As the company matures, base salaries begin to gel and basic ranges start to be set for various levels of employees and functions. It is at this point that the founders start to act like senior executives and formalize their compensation. And as the company hires senior executives, base salary compensation starts to be coupled with significant variable bonuses.The best approach to launching the compensation process is for the Board to start it by asking the CEO to put the plan together (with the help of the CFO) for approval by the Board. I am assuming here that the company already has a balanced and cohesive board.At some point in the company’s maturity, the Board should set up a Compensation Committee. At that point, the compensation committee would take control of the process by setting up and delivering the plan to the Board for approval. It is best for an independent board member to chair that committee, preferably one with finance or accounting skills.2. Set bonuses for annual payouts, not quarterlyAnnual bonuses have an exponentially larger psychological impact on employees and their families than quarterly payouts. By breaking up the bonus into quarterly payments, you are cutting them into smaller slices where they will simply become part of the base salary. The bonus won’t be a big deal for the family, and probably won’t even be received with excitement. But an annual bonus would. It gets paid around the holidays. It is awaited with great anticipation. And it hopefully is big enough for the family to take notice. Perhaps it pays for a nice vacation, a new car or a new house.The other reason we like annual bonuses is that it gets the senior team focused on the annual strategic themes, the annual budget and the long-term results of the company. In expansion stage companies, quarterly results are means to a bigger end.Annual bonuses also make it easier for the CFO to manage the plan, without having to worry about quarterly ups and downs leading to excessive payouts and subsequent drawbacks.3. Bonuses should be earned, not expectedDon’t treat any part of an employee’s bonus as guaranteed pay. I have seen many a CEO use bonuses as an extension to the base salary; as a way to negotiate down the base salary, but still meet the employee’s baseline pay expectation. In that case, you are better off taking the guaranteed portion of the bonus, pay it out as base, and leave the remains to be a true bonus.4. Tie the senior executive’s bonus to the annual budgetUltimately, the performance to budget is what truly matters in the expansion stage. As expansion stage investors, we like simple bonus plans that tie payouts to the top and bottom lines of the budget. We like plans that are set up as a matrix with one axis showing the top line (bookings is typically the best measure) and the other axis showing the bottom line (typically earnings, although I have seen gross profits, sales and marketing economics or cash flow).Some comments on this structure:The company set the budget bookings target at 80% of the sales quota bookings. And used the quota bookings (and associated bottom line) as the target to communicate to employees. The idea is to set an achievable budget to report to the Board, and set a stretch goal to the employees.The 50-95% bonus payout (shown in yellow) was set around the quota bookings stretch goal. Effectively, the motivation is to over perform against the budget (but still not make 100% of bonus) Performance under budget (shown in red) penalizes the bonus exponentially to zero. This is very important. Paying bonuses when the company misses its budget by more than 10-15% is unacceptable and sends the wrong message about performance-based pay. The matrix, and the band around the targets, provides the Board with a mechanism to react during the year to a changing environment. Perhaps the Board would like to see a higher bookings level achieved with some sacrifice to profitability. Or scaling back on bookings to aim for higher profit if the market softens and cash becomes constrained.5. Put the whole senior team on the same compensation planIt is important that the senior team is focused on the same goal when it comes to bonuses. While it is true that each functional executive has his or her own goals and targets, financial performance is the goal, and senior team members need to be focused on helping each other hit and exceed the budget.AddThis Sharing ButtonsShare to FacebookFacebookShare to TwitterTwitterShare to PrintPrintShare to EmailEmailShare to MoreAddThis4last_img

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