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).

Executive MBO Template

Note that the scorecards are only 1 or 2 pages per executive.  You want to include both high level strategic goals as well as tactical / tangible milestones.  And most importantly, you want to give specifics about relative priority and how you're connecting these performance metrics to pay.  Remember that you almost certainly won't get this right the first time but that each year you will get close and closer to a predictable system.

Lastly, once you have this framework in place, make sure to benchmark your salary, bonus and equity for each position in your company using CompStudy data which allows you to narrowly focus on companies that meet your profile and the executive position in question.