Small Business

How to Structure a Bonus Plan


Before you promise anything, determine your financial obligations, then base the bonus on profit or revenue, or use a flat fee

I am opening a small business and hiring my brother-in-law. I offered him bonus payouts based on overall end-of-year profits. However I want to pay off my Small Business Assn. loan quickly. If I do so, that would cut into my profitability and in turn cut into his bonus, which I don't want to do. He will be a huge asset to the company. What is the best way to structure a bonus plan for him?

—R.H., San Antonio, Tex.

There are several ways you could set up a bonus plan based on your company's profitability that would also allow you to pay off your small business loan in a timely fashion.

Probably the best option for you would be to base your brother-in-law's bonus on the company's profits before you make the loan payments, says Jason Kovac, a practice leader at WorldatWork, a nonprofit compensation and benefits organization based in Scottsdale, Ariz. "Calculate your annual profit without including the loan payment as an expense, then pay out the bonus as a percentage of that profit. You'd make your loan payment after you've paid the bonus. By taking this approach, your brother-in-law will receive a full bonus and you will still be able to pay off your loan," Kovac says.

Another possibility would be to base the bonus on a percentage of your company's revenue, rather than its profit. "Typically when you set up a bonus plan, you base it on profit. But you could alternatively base the bonus solely on how much money comes in, without figuring the expenses," Kovac suggests. You'd probably want to decrease the percentage you're using to figure the bonus, so if you planned to give him 20% of profits, you might give him 10% of revenues. Even so, your brother-in-law might get a larger bonus and a more immediate payout, since you wouldn't have to wait to calculate profitability before figuring his bonus.

Deciding on the Size of the Bonus

A third choice would be to base the bonus on a dollar amount. So you might decide that if all your company's goals are achieved in its first year, you'll pay him a flat fee of, say, $3,000. You could tie the bonus to a financial goal, such as achieving a certain level of revenue, or a non-financial goal, such as attracting a set number of clients. "The advantage here is that your brother-in-law would be guaranteed a certain amount of money as a bonus, instead of having the bonus fluctuate as it would if it were based on a percentage," Kovac says.

How do you decide what size bonus is a fair offer? There are proprietary salary and bonus surveys you can purchase from business research firms such as Salary.com (SLRY). Or you can look for information at the U.S. Bureau of Labor Statistics. Kovac says you can even get a lot of useful information for free by searching online.

"Spend 15 or 20 minutes on Google (GOOG) and you'll see that a lot of the survey vendors do articles for newsletters and Web sites that disclose some of their findings. I don't know that what you'll find will be 100% accurate, because you may not know where in the country the data comes from or whether it's self-reported, or company-disclosed data, but if you just need to get an idea that's in the ballpark, you should do OK," he says.

Karen E. Klein is a business journalist who covers small-business issues for several national publications. She writes her Smart Answers column twice a week.

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