If you’re like most independent advisors, you probably discontinued your employee bonus program at the end of 2008, when you realized you were committed to pay “performance bonuses” despite the fact that firm revenues were falling dramatically. For 2009, with revenues back up again, you may have paid your employees what I call a “spot” bonus at year’s end: an amount based on nothing more concrete than your assessment of what you could afford to pay and your feelings about what each employee deserved.

In 2010, now that the worst of the economic downturn seems to be behind us, it’s time to once again take a more serious approach to employee bonus compensation: first, by paying another “spot” bonus at the end of the first quarter; and by implementing a more formal bonus program, this time based at least in part on firm performance, to avoid being caught again with an empty bag at the end of the year.

Why pay another employee bonus so soon? Two reasons. First, that spot bonus you paid at the end of the year, while much appreciated by your employees, I’m sure, probably didn’t come close to the amount you paid out in years past–even though your revenues had almost recovered. That’s understandable: You’re still a bit shaken from the events of the past year, and are having a hard time paying out any money that you don’t feel you “have to.” But if you’re going to get your practice back on the path to prosperity during the recovery, you’ll need to put your fear of the past behind you, and make sound decisions based on your present circumstances.

Which brings us to the second reason for another bonus: Retaining your professional employees. As I’ve written before, many far-sighted advisory firms today see the recovery as a growth opportunity to attract substantial numbers of new clients shaken by the collapse of most major wirehouses and otherwise unhappy clients with the advice they got both before and during the Mortgage Meltdown. To do that, they need to replace professionals laid off during the past year, and/or beef up their staffs with young professionals to leverage older advisors so they can focus on bringing in new clients.

And where are they going to get these young advisors? That’s right: from firms who have failed to make their now much-more-experienced junior advisors feel appreciated for the sacrifices and loyalty they have shown over the past year. To make sure that your firm isn’t one of those, it’s time for another spot bonus: to show that now your business is back on sound footing, you’re more than willing to share the benefits with the people who helped you get through the tough times. Now is no time to get greedy.

Toward a More Rational Bonus Plan

Now that you’ve shared the wealth, and made your supporting cast feel how much you value them and their commitment to the success of your practice, it’s time to create a bonus compensation structure that will help you keep doing that, in good times and in bad. As I mentioned, one of the silver linings of the meltdown is that it exposed most “performance-” based bonus plans for the bad ideas that they are. Now you have a chance to create a more rational program.

The problem with performance-based plans is that they are typically dissociated from the success of the firm. Now, by “performance-based” I’m talking about bonuses that are based on specific accomplishments of an individual employee. They might be specific tasks, such as transitioning to a new CRM program. Or it might be attaining a new level of personal development, such as getting the CFP or improving client communication skills. Regardless of what the employee’s individual goal is, a performance bonus comes with two major drawbacks: the bonus isn’t tied to the fortunes of the firm, so regardless of how far revenues fall during the period under review, if the employee reaches the specific goal, you owe them the bonus, period. Worse, the bonus creates no incentive for the employee to work toward the success of the firm, only toward her own betterment.

Consequently, the best compensation plans pay at least a portion of an employee’s bonus based on a share of either profits or revenues. Now, I know that many consultants recommend firms pay bonuses through a profit-sharing plan. To my mind, this is yet another example of applying management strategies that work well for large corporations to small businesses, resulting in far less successful outcomes.

There’s an old rule of thumb in movie investing that you should never base your return on a percentage of profits, because there never are any. The same goes for small businesses, at least in principle. One goal for many small businesses, including advisory firms, is to show as little profits as possible. The point is that in privately held advisory practices, the owner(s) have far too much control over profits to make them a fair basis for employee bonuses. Think you have morale problems now? Imagine if the cost of that “convention” in Hawaii, or your new BMW was coming right out of your employees’ pockets?

In my view, the best basis for employee bonuses in an independent advisory firm is revenues. Sure, you can peg part of the bonus to revamping your Web site. Or if a junior advisor is responsible for bringing in new clients, she can be paid directly on her success. But the best way to align employees’ interests with the success of the firm (and avoid creating ill will over how you’re spending the money) is to pay them a portion of the revenues.

The Benefits of Revenue-Based Bonuses

What’s more, revenue-sharing bonuses also avoid the problems exposed by the last year’s crisis: owing flat bonuses when revenues have fallen and there’s just no money to pay them. With revenue sharing, when firm revenues go down, employee bonuses go down accordingly. In fact, none of my clients who tie bonuses to revenues experienced any loss of morale when revenues fell: The employees understood where their bonuses come from, and when revenues went down, they understood why their bonuses did, too. In fact, it actually enhanced their feeling part of the team, and their sense that “we’re all in this together.”

So why don’t more firms use revenue-sharing strategies? In my experience, it boils down to one thing: fear. Owner/advisors are afraid that revenues will go up, way up, and they will end up paying out a lot in bonuses (see A Self Defeating Mentality sidebar).

If, on the other hand, you want to grow your firm to a multiple of its current size, you’ll need to leverage yourself with more employees, particularly professional employees, a strategy that offers the most growth bang for the buck–and you’ll have to motivate them to act and think like owners.

That means you’ll have to take a smaller portion of your own pie–at first through revenue sharing, and eventually through equity sharing–so it’s in your best interest to overcome any short-sighted, greedy instincts you might have, and do everything you can to grow that pie as large as possible. Right now, the best place to start is get that second “spot” bonus out as soon as you can. Then get to work on a plan to share your revenues in the form of bonuses: you’ll quickly find that sharing your success will result in a whole lot more of it.

Angela Herbers is a virtual business manager and consultant for independent financial planning firms. She can be reached at angieherbers@cox.net.