When compensation is based on pure profit sharing, every team member's pay is directly proportional to the compensation of the group as a whole.
We were speaking with another entrepreneur last week about how to build a team to create sustainable value growth. He noted that we had a highly paid staff (average salary is well over $100K) and asked us how we structure our incentives. We described our compensation model as pure profit sharing.
Sure, the owners make more than the employees in a good year and less in a bad year, but every team member's compensation is directly proportional to the compensation of the group as a whole. Here are the mechanics of how we do it:
1. Focus on Total Compensation, Not Bonuses
Everyone is paid a base salary based on his or her level of contribution in the previous year. We like to think of it as a "draw" on total compensation rather than a salary. At the end of the year, we fund the total compensation pool based on the firm's performance. The total pool ranges from one to two times the sum of all base salaries, which means in a fantastic year, we will pay out double base salaries on average.
Next, we rank everyone on an objective scale relative to his or her total value contribution to the firm. There is a fixed relationship between someone at the top, someone in the middle, and someone at the bottom--in other words, the most valuable person will make about four times as much as the least valuable person. Then, we calculate total compensation for each individual based on that relative scale. Whatever we paid him or her in base salary during the year is subtracted, and the rest is paid as a year-end bonus.
2. Create Unlimited Upward Mobility
Any individual has limited ability to increase the total compensation pool by him- or herself, but he or she has almost unlimited ability to move him- or herself up in the rankings. Our rankings are based on your role in terms of service to clients and investors, and building the value of our portfolio companies. Therefore, each team member has a strong incentive to move into a role in which he or she can create more value and prove him- or herself with tangible results in that role.
Because base salary doesn't matter, individuals can move themselves into a more valuable role and, if successful, increase their value ranking within the firm. This isn't competitive, because anyone who creates more value increases the size of the total pie, which benefits everyone on the team.
3. Encourage People to Self-Select Into a Role
Our compensation method creates a fairly clear choice for someone who is motivated to create more value and make more money. Everyone can plainly see what he or she has to do to hit a specific compensation level. We can have an honest conversation about how to get someone in a role in which he or she wants to be and what he or she must accomplish to get there.
In some cases, people realize they are not set up to achieve the compensation they are looking for or, in extreme cases, they are not positioned to receive a bonus. In these cases, people are encouraged to restructure their role or leave the firm.
We find that when you create a fair compensation model, people are encouraged to do the right thing for the organization's success. Our team likes the fact that we have a high-performance culture where one has the ability to earn much more and gladly accepts the downside potential. Fortunately, because the team is highly motivated by this model, we rarely realize the downside.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark