Cash Bonuses Come Back Around

I recently was involved with a start-up company where the CEO decided that he and his team should get cash bonuses in addition to the regular compensation that they would get otherwise. The issue that I had at the time was that the proposed plan gave them bonuses on a sliding scale starting with about 60% of the revenue forecast that was a part of the Annual Operating Plan. When I suggested to the CEO that it created a reward for missing the operating plan and that these parts should be removed, he reacted very negatively to the thought. This led me to rethink the whole idea about start-up companies and cash bonuses.

Motivation:

The idea of paying for performance isn't all bad, but the problem with bonuses at start-ups is that generally cash is the thing that the start-up has the least amount of. Giving it away in bonuses just shortens the time till the company either runs out of cash or has to raise some more. This should be avoided as much as possible and then only done for very limited purposes.

Upsides:

Salary Matching - The one place that I've seen cash bonuses used effectively is when a prospective employee is being sought and there is a big mismatch in their base salary. Sometimes using a cash bonus as a way to create a short-term bridge provides a way to get the employee on board and let them justify their ultimate higher (permanent) salary. If the employee proves they are worth the money, no problem - management will raise the salary. If not - the employee will either have to adjust their lifestyle or find someplace else to work.

Greed is good - Many people are motivated by money, but some are motivated by doing something important for the world, even if there isn't the same cash reward. I suspect that if you lined up people from left to right according to how motivated they were by cash, you would find the sales personality types on the left and the engineer personality type on the right. If a person is a natural gambler, a bonus is an effective motivator, but only if tied to a relatively low base salary.

Downsides:

Alignment - One of the problems in constructing a bonus and MBO plan is the construction and management of the plan. Things usually start-out well, but it doesn't take long before things are change and the bonus and MBO plans actually lock people into old behaviors and keep them from working together. For instance, take a company that has a bonus plan built around R&D and a Sales budget assumptions. The CEO will have a more difficult time moving money between the buckets if it will ultimately result in one VP getting less of a yearly bonus than another one. The net result is that the CEO will spend a lot of time on people issues, where he could have been working on customer issues instead.

Entitlement - The idea of an Annual Operating Plan is to give the company a can't miss revenue plan and a set of expense targets that gets the company to the next level of risk reduction. By constructing a bonus plan where the team gets paid even if they miss the plan tells the team that plans aren't all that important since they are going to get even more money even if they miss the plan.

Big company mentality - The personality type that likes bonuses is often that of a bigger company where the overhead is higher and the productivity is lower than typical start-ups. Big company people have their place in start-ups, but having them there too early creates tension that management shouldn't have to deal with.

Gaming the system - I worked with a company one time that was late delivering their product to the market. The CEO argued that he should give a bonus to the sales guy, even though he hadn't sold anything since it wasn't his fault that the product wasn't ready to ship. That mentality leads to a pretty mediocre company where nobody is accountable for anything, particularly since they are going to be paid a reward for exceptional performance anyway. The company ultimately went out of business because it ran out of cash and new investors didn't like the way money had previously been spent.

Kills Teamwork - I also worked at a bigger company that had a bonus program, and observed that several managers had a zero-sum attitude that anything they did to help you would hurt them, so unless there was an obvious quid-pro-quo, they weren't interested in helping out. The creation of a zero-sum mentality can permeate an organization as well.

Cash is the most precious resource - As if the pressure of starting something new, dealing with new people, pioneering a new market, dealing with aggressive competitors and managing a new team weren't enough, adding the pressure of running out of cash sooner really hurts. There are a lot of stakeholders that wind up losing out because of this management greed.

Makes the investors wonder - As a potential investor in deals, it is important to look at cash flow statements and expense charts to figure out how money has been spent in a company. If the company has a history of doing dumb things with investor money, they probably will continue to do dumb things with your money as well. Spending money on practices that many consider as controversial can lower the chance of getting future funding into the company and that could threaten the existence of the company.

Conclusion:

Of all of the experiences I've had with start-up companies, the biggest arguments that I've ever had with CEOs have been over the use of cash for bonuses. Fortunately they are relatively unheard-of in the start-up world, but they do occur often enough to merit some thought. This leads me to the conclusion that cash bonuses in start-up companies are a really bad idea - there are some potential upsides, but the numerous downsides outweigh them. I often have said that cash bonuses in start-up companies are 'the work of the devil', and now I am even more convinced. If I were an investor in a pre-earnings company that was giving out cash bonuses, I'd question the wisdom of the management and be mad that my money was being wasted.