VisionLink Blog

Robert Rainey

Making Bonus Plans More Effective

One of the inquiries our firm receives more than almost any other goes something like this: “Can you help us fix our bonus plan?”  The question usually stems from the company having tried a number of iterations of a bonus arrangement over the past few years and feeling like it isn’t “working.”  Sometimes these plans are largely discretionary, other times they have become a virtual entitlement. And more times than I can count, the company has put itself in the position of paying out value when it isn’t even profitable.  Yikes!

With that frame of reference in mind, let me share some steps that should ensure a more effective annual incentive plan arrangement.  While each company is different, and you may have metrics and measures that vary according to your circumstances, this planning sequence should help you organize things in a way that protects shareholders while providing a great plan for participants.

Bonus plan design works best if it is approached as follows:

  1. Determine the eligible group.  You may want to begin with primarily executive or management employees and expand later from there.
  2. Next, assign eligible employees to tiers based on salary, roles and responsibilities. The number of tiers will depend on the size of the eligible group, but there are 3-6 for most companies.
  3. Determine how profit will be defined for purposes of the new plan.Common measurements include: EBITDA; net operating profit after tax; earnings before taxes; operating income; net free cash flow; etc. Measurements may be expressed as benchmark/budget numbers (e.g., $1 million of EBT) or as a growth in profits approach (e.g., 10% increase in EBT from prior year).
  4. Establish a minimum threshold of financial performance (as determined in step 3) that must be met before the funding of any incentives. For example, if using a benchmark/budget approach it might be determined that the first $X of profits will not be subject to the incentive plan. With a growth in profits approach, it might be determined that the first 6% of growth will not apply, but any excess will.
  5. Select the percentage of profits to be credited to the Bonus Pool (“Pool”). This might be a straight percentage (simplest) or a tiered percentage (that rewards higher values for better results).
  6. Allocate the entire Pool to the different tiers using one of following methods:
    1. Percentage to different tiers (e.g., 40% to senior management, 20% to middle management, 40% to all other employees)
    2. Discretion of board/CEO/shareholder(s)/executives/managers
  7. Allocate each tier’s Pool among the plan participants utilizing one of the following methods:
    1. Individual performance score (requires internal job appraisal system convertible to scoring result.) Employee evaluations may impact individual participation in the profit award. That is, the evaluation scoring system can influence the amount of the allocation to be received (e.g., a 100% system).
    2. Discretion of board/CEO/shareholder(s)/executives/managers
  8. Calculate each employees bonus as a percentage of his salary based on the results in step 7
  9. Adjust the allocation (entire Pool and/or participant) as needed to reflect relative performance/value of each tier and/or the participants.
  10. Determine how company would like to express the bonus opportunity to participants. “Your bonus opportunity will range between 20-40% of your salary, depending on the level of profits we attain.” “You will receive approximately y% of all profits in excess of x.”
  11. Develop management processes to communicate and reinforce the profit-generating capacity of all employees. During performance reviews, goals should be set that are tied to profitable activities. Conversations between management and employees must reflect an understanding of the importance of achieving profitability goals and of each associate’s contribution to the same.
  12. Apply consistent judgment and evaluation standards. A review committee should oversee the process to assure the highest possible commitment to consistency, fairness and diligence.

These steps, of course, have to be modified to fit the specific needs of each organization.  In addition, ideally those building the plan will construct a financial model to test the metrics that are developed for the plan and project its potential impact at various levels of performance such as base, target (budget) and superior.

To learn more about the principles and practices addressed here, check out our recent blog entitled “Pay the Company First”.

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CLIENT SUCCESS STORIES

"VisionLink has helped us successfully navigate a number of complex issues regarding our rewards programs. It has dealt with all facets of these varied issues with a high degree of competence, integrity, and straight forward advice. VisionLink's experienced team has consistently delivered first class results in a timely, professional manner and has become a valued Storm partner."

Thomas K. Grzywacz
President/Chief Executive Officer
Storm Industries, Inc.

"VisionLink has helped us successfully engineer a long-term incentive plan that has empowered our company to reward and retain key talent while increasing shareholder value. The knowledge, patience and deep experience of its team members helped us navigate a road that was unfamiliar to us. Ultimately, VisionLink designed a plan that met the high standards of both stockholders and key management employees. We have further engaged VisionLink to address our business succession and transition planning needs."

Reggie Dupre'
Chief Executive Officer
Dupre Logistics

"Over the past several years, National Technical Systems has engaged VisionLink to provide insight and direction on a number of executive compensation issues, as well as a performance evaluation of our 401(k) plan. Under its direction, NTS completely revamped executive level rewards to align with our business growth objectives and the strategic plan of the company. VisionLink's insight and direction have been invaluable. NTS has achieved its growth objectives and our executives feel appropriately rewarded for their performance."

Bill McGinnis
President/Chief Executive Officer
National Technical Systems

"VisionLink arrived on the scene just in time for us. We needed a new framework for our short-term and long-term incentive plans. VisionLink's modeling and forecasting process broadened our horizons and expanded our view of how to use a good incentive system to build, retain and strengthen our senior management team. We remain impressed by their expertise, professionalism and great service."

James Keng
Chairman
Jimway, Inc.

"Our firm has had a long-term incentive plan for over eight years but we never quite felt like it was firing on all cylinders. We hired VisionLink to re-energize our plan, and they did it! We now have a cohesive awards strategy that's fair to shareholders and valued by our employees. VisionLink's team is technically skilled and very creative. We're happy to recommend VisionLink to firms looking to upgrade their management incentive programs."

John M
FTO Inc.

"Our company was like VisionLink's typical clients. We were great at sales and haphazard at how we compensated our people. VisionLink's process brings great clarity and confidence to our growth planning - and makes compensation a great growth capability."

Dan Sullivan
Founder and President
Strategic Coach ©

"The team at VisionLink helped our company structure a long-term incentive plan that parallels the company's strategy for continued growth as a global market leader within our industry. Their approach resulted in a program that our corporate team and executives embraced on both a professional and personal basis. Through VisionLink's guidance and execution, we were able to create both a motivational tool for current team members and a recruiting device to attract future executive level associates. Well done!"

Mark Rhoades
President
Fluidmaster, Inc.

"As a leading direct seller of scrapbook photo albums and supplies, Creative Memories has independent consultants across the country. And for over six years now, VisionLink has helped us to stay connected and administer a voluntary 409A non-qualified plan for them. VisionLink has provided support for all aspects of our plan from notification of eligibility through registration and distribution. The VisionLink support team has offered suggestions for improving processes and provided us with outstanding service year after year."

Guy Walker
President
Creative Memories North America

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