Tough Love on Year-End Bonuses

Bonuses based on revenues (the best structure, in my view), create the least dilemma: employees’ bonuses (as a fixed percentage of revenues) falls as firm revenues fall. Employees’ fortunes are tied to that of their firm, which is the whole point. Practice owners should resist the temptation to increase employees’ share out of their own pocket–that’s just too patronizing–instead, they might pay a mid-year bonus, if firm fortunes sufficiently turn around by then. The same goes for bonuses based on profits, which, due to the rather arbitrary nature of profits in a closely held company, is my least favorite comp structure.

The bonus packages that are giving advisors the most headaches these days are flat-rate merit bonuses: Where owners determine the dollar amount of bonus that each employee’s performance warrants at the end of the year (or in the annual review). In turbulent markets like this one, when revenues are down and firms are struggling financially, doling out lump sums based on performance becomes a problem.

On one hand, with stress and client workload running high, employees who step up certainly deserve a good bonus based on merit. But on the other, with profits shrinking precipitously, often those bonuses will have to come right out of advisors’ pockets. And even if your practice had set aside a cash reserve (which I highly recommend), it’s best used to keep the doors open and client service at a high level.

One common solution I’ve seen lately is for firm owners to give IOUs to their employees for this year’s bonus, to be paid sometime next year. I have serious reservations about this approach. For one thing, what happens if firm fortunes don’t recover as quickly as you expect? Another IOU next year? Moreover, what’s the effect on practice finances when you have to pay off these debts next year, in addition to next year’s bonuses?

I know that giving out IOUs makes firm owners feel somewhat better about not paying bonuses this year, but it shelters employees too much. It’s far better in my opinion to explain your firm’s financial situation to the employees, tell them how all this is affecting you and your income, and show them why you just can’t afford to pay out a bonus this year. But tell them, too, that when things turn around, you’ll be more than happy to share the practice’s renewed revenues with them in future bonuses. That way, you haven’t added to your debt load, and you’ve helped your employees to see how and why their financial interests are directly connected to those of the firm. They’ll be better employees for it.