Build Win-Win Bonus Structures That Motivate without Overpaying

I'm Melissa Shanahan, and this is The Law Firm Owner Podcast Episode #305. 

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Hey everyone, welcome to this week's episode. So glad you're here. If you haven't listened to last week's, last week's is really part one of two episodes I'm doing about incentives and bonuses. And just trying to give you the knowledge that's in my brain so that you can come up with something that's really healthy for your firm. So, if you haven't listened to last week's episode, go do that first. Sometimes, when I have to break up an episode because there's too much content for just one, it doesn't really matter which one you listen to first. This one does. You do need to understand what I'm talking about in the first episode, Episode #304, before you listen to this. It's going to make way more sense with what we're talking about today.

I don't remember if I said this towards the end of the episode last time or not. I know I said it at some point in the episode, but I think it's a good reminder. And so we're going to start with this right up front. When it comes to incentives or bonus structure, you must go slow when trying to figure this out. Because if you roll out the wrong thing, it really screws everything up. Not only is it the short end of the stick for someone, whether it's the firm because you're giving too much to the employee or the team member, or whether it's too difficult for the team member to hit. So then that's not a good incentive.

You have to remember, incentives are supposed to be a win-win. A win for both parties involved. And very rarely do I come across an incentive or bonus structure that is in place in a firm that that is the case. It is usually bent one way or the other, someone is losing, and someone is frustrated. Someone is getting the short end of the stick, so to speak. And the owner doesn't realize it, or sometimes they know it. They know that they're paying out way too much to the team member, but they don't feel strong enough or confident enough to change it.

So I'm going to address that right up front, and then we're going to dive in and pick up with the content that left off last week. So here's what I want to say about that. Your job is to be a good steward of this business. If the business isn't thriving, no one else will, including you as the owner, but no one else will. When a business is feeling constricted because of tight profit margins and cash flow being tight, no one wins. When the firm is struggling, then it means that your impact and the ripple effect that could come from the firm is totally cut off. There is not enough to go around, and there's no excess at all, so there's no options in front of you. You just have to keep doing what you're doing and hold it in tight.

Your firm is like a living, breathing organism, and you have to take care of it. If you don't take care of it, it starts to become really unhealthy. It starts to shrivel up, it starts to shrink. If you don't think about your firm as a living, breathing organism, then you need to shift your perspective. You need to start looking at it that way. Because if you did that, then you wouldn't do things to compromise the health of that living, breathing organism. It is your job to make sure that this business stays healthy and continues to either get to a place where it can thrive or, if it's already thriving, continues to be that way. That is the best position you can put yourself in.

For that business to be healthy, it means it's able to really feed all the things it's supposed to feed. It can be what it's supposed to be for everybody. That means in serving your clients. It means winning for you as an owner. There's margins, you're able to take distributions, you don't have to think so hard about every penny. You should know where every penny's going, but you don't have to think so hard or get stressed out about taking some money out of the business.

So that's on one side. And then also the team can win. If the business is healthy, there's room for these kinds of things. But if they're put into place in a way that compromises the business, it becomes very difficult. It's almost like the employees start to win if incentives are put in place that aren't really thoughtful, and that means that they are tilted too much in the favor of the employee. And this isn't about the employee. This isn't about if they're doing a good job or a bad job. This has nothing to do with that.

It's just the deal. The deal that's on the table isn't a fair deal to the business. And if that is the case, you have to fix it. And if you don't fix it, you have to look at why you're not fixing it. Most of the time it's to do with fear. Sometimes it is ignorance, like people don't realize it.

But this episode, I'm hoping will help you do what it takes to figure out if it's a win win on both sides, or is there too much cash going out to the team member? And one way that you know that is if the business feels too tight.

If the business feels too tight and your team members are getting big upside with incentives, this is wrong. The business comes first. The health of the business comes first. If the health of the business is not intact, then nobody else gets extra. That should be a rule. If the business health is not intact, when there isn't stability month over month in this business, you have to be very thoughtful about incentives that you put into place because incentives can do really cool things for the team. It can motivate the team. There's nothing wrong with putting something into place when the business is struggling.

But you have to play it out all the way to the end. We'll talk a little bit more about that today, so that you know for sure that if the team member knocks it out of the park, the business is getting what the business should be getting. And the team member also gets a reward. So it has to be a healthy balance. I'm not saying don't put any incentives into place until you're healthy. I think incentives can be a really cool tool in order to sort of light a fire under people in order to create stability.

But I could feel myself sitting here thinking, why are you doing this episode? It's so depends on the situation. What was just running through my head was, yeah, incentives, you know, there we talked about last time, the difference between an expectation and a goal, which is a stretch goal. And so when you put an incentive into place that people aren't even hitting the minimum, the expectation, I could see where people would think that what I just shared is contradictory to what I shared last week, but it really does depend on the situation.

If you've been a crappy leader, if you have not been showing up the way you should be showing up. If you have not given truly the resources and the tools and the attention, and the focus so that the team can hit their expectations, and you want to shift that into gear, there are different ways you can approach that. And one is to institute like a training program. We're all going to go through this together. We're all going to learn this together. We're all going to hold each other accountable for this standard, this expectation that we have, because we haven't done that before and we should. There's no reason not to. So that's one way you can handle it. 

Another way, or an additional way that you could help kick people into a new gear or help them find a new gear, even if that gear is the expectation, not the stretch goal, is to do some sort of short-term incentive. Just to say, hey, we should be hitting this at a minimum every week or every month, and we're not. So let's just kick ourselves into gear. We're going to train together on these things. I'm going to meet with individuals on X, Y and Z. And for the next six weeks or eight weeks, when we hit that expectation that we haven't been hitting for a long time, then to reward ourselves for creating the new normal that needs to be created, this is the incentive that we put into place.

And again, we'll talk through some of the math and how to think about this, but with your scenario, you just need to play it out and make sure that okay, if they do knock it out of the park with this incentive, am I really okay paying this out? And am I really okay with what the business gets to keep because of the effort that everybody's putting in?

So, I'm just sharing that this is why I've hesitated on these episodes because there are so many different variables to look at when you are deciding what incentive structure or bonus structure to put into place. And you just have to check it out from every angle. You have to be able to stand on two feet solidly and say, this is why I'm doing it this way. Or this is why I'm not doing it this way. You need to be able to defend it, to argue it to the end. Not just for the justification that is in your mind at the moment. No, play that puppy out. And then be able to defend the whole journey, the whole payout.

If they don't do well, what are you going to pay them out? If they do very well, what are you going to pay out? And what does the business get to keep in both scenarios? Does that seem fair? Does that seem healthy? And by the way, the business should keep most of it. Not, it shouldn't mostly go to the employee. Are we helping the business thrive? Or are we getting them to do what we want them to do, but the business doesn't get to keep the upside, at least not very much, not enough to make a difference? Then that's not a good incentive plan.

There's just so many variables that go into this and that's why I just stopped a minute ago and thought, oh man, someone's going to be listening to this and take this sentence that I say and run with it without looking at the bigger picture, without doing all the other things I'm sharing here, without considering all the things that need to be considered. So please don't do that. You will hurt the firm. You cannot just throw something into place. You cannot wing this. You really do have to be thoughtful.

All right, so let's pick up where we left off from last week. At one point in the episode, we talked about baselines and figuring out your true average, which I covered, and adding 10% to it, and that's the baseline. Well, here's what happens. Over time, baselines shift. Because if you remember, with the true average, it's the twelve-month average of whatever number you are trying to incentivize. It could be number of new cases, for example. Let's just use that.

You take the by month, you always look by month. By month, what is the twelve-month average of new cases that came through the door? What is the six-month average of the cases that came through the door? And what is the three-month average of the cases that came through the door? You add those numbers up and you divide by three. And that gives you a more fair look at the last twelve months and protects against anomalies or seasonal stuff where, you know, one quarter is weighted heavier than another, then okay, so this kind of evens the playing field and really does get a better true average.

So, when you get your baseline, because it's the true average plus 10%, that's the expectation. We've done this in the last twelve months, we can add on 10%, that becomes the baseline. And then as we talked about last week, you can incentivize anything over the baseline. And that's because you're incentivizing a stretch. You're not incentivizing the norm. You are incentivizing a stretch.

So, what happens when the baselines shift? Because you set these, let's say you do the twelve-month, six-month, three-month average, you get the true average, and then you add 10%. And then you put an incentive into place, and then next year you do this calculation again, or you do it in six months, whatever. And everything bumps. The true average is actually higher now because people have been performing better. They've been hitting their stretch goals.

So now the baseline is different. In the past, I've worked with many, many, many, many, many people that have operated this way. And what they run into is that they don't give raises. This is something that I would see so commonly. They don't give raises. They would just shift the incentives and say, this is how you make extra. If you want to make extra, then you need to hit your incentives. And yeah, they do change over time because this is built on an equation, and your true average is changing.

So your baseline's going to change, which means your incentive, the tiers are going to change, anything above the baseline. And that really ticks people off over time. It sounds great the first twelve months. And then the next twelve months rolls around or whenever they're reset, and it all of a sudden doesn't seem fair. It feels like I have to do more work for the same amount of money. That doesn't feel right to people, naturally.

So a better way to deal with this is to give a raise every year, like a cost-of-living increase raise. It doesn't have to be something huge. But give a raise because cost of living does go up. Things do change. Circumstances are harder. Like people have real things they're dealing with, and to just keep their salary year over year the same, and tell them if you want to make more, this is your incentive program, go for it. But it's like the horizon, the target keeps moving. They can't ever really make more.

So that is not a good approach, and it's so crazy to me how many people try to do that. It doesn't work. People are not going to stay loyal to that. It's going to tick them off. So that's a no. You need to give raises. Now I'm not saying again, it doesn't need to be a big raise, but you need to be thoughtful about increasing their pay as it should be increased. And when you do that, plus then you move the goal post because their new normal is what used to be a stretch. Okay, we incentivize stretches. We don't incentivize for expectations. And creating new normals within the business is very healthy. Creating new normals anywhere in life is very healthy.

When you really strive to achieve something, a different level with something, and it is your new normal, that's awesome. It should be celebrated. And getting yourself there, there's nothing wrong with an incentive. There's nothing wrong with not having an incentive. I will say that. I just want everybody to hear me when I say that. You don't have to have an incentive program in order to create new normals in your business. That is not what I'm suggesting. But it is something you can do and it is something a lot of law firm owners want to do, but you need to do it responsibly.

Okay, so what happens with baselines shift and how to handle it? Your people grow, they grow their capacity, their abilities, your business grows, and because of that, the baseline will grow. So what do you do? Number one, set expectations up front. This baseline reflects where we are today. If performance trends upward, we may adjust annually to keep the incentive meaningful. It's important to adjust the incentives to stay tied to stretch performance. And you can say that up front. You are incentivizing them for the stretch. You're not incentivizing them for normal.

After you set expectations up front with this, you need to reevaluate these numbers and recalculate the baselines yearly. The only time you would do it sooner than a year is if it was decided ahead of time, and this shouldn't happen very often. It should happen at the beginning or when there's a really big change in the firm where you say, you know what? We're going to recalculate the baseline at six months because the numbers that they're starting with, if they're so low and the baseline is so low, then it means that those numbers really need to hit a healthier place for the business. And you don't want to pay out an incentive on something that it really should have been better from the get go.

But okay, here we are. We're going to set a stretch goal. You guys need to hit this. This needs to become your new normal. And if that new normal is just like what should be expected for the firm, this kind of goes back to what I was saying earlier, putting a short term plan into place to just get everybody moving in the right direction and get them lined up with the expectation, that can be great.

But that incentive plan can't be paid out for a full year. It's more of a short term thing. It could be three months. It depends on the number, it depends on how hard it is, it depends on what's going to have to happen in order for them to really stretch. But shorter term, if you are starting really low and there's so much room for improvement and it's not going to take a lot to move the needle, I would not put anything into place for twelve months. It needs to be shorter term.

Now, if it's like, hey, we're doing pretty well. Let's see what's possible here. We're going to calculate the baseline and we have some stretch goals above the baseline. Then twelve months is fine. It's totally fine. But it really just depends on where you're starting from. If you're starting from a very dire place, do not put a twelve month plan in and pigeon hole yourself into having to stick to twelve months right up front.

So, generally, you want to recalculate the true average and recalculate the baseline yearly, unless there is a scenario like I've been speaking about. But you only adjust the baseline at planned intervals. You cannot adjust the baseline because you feel like it or because you're noticing how well everybody's doing. You have to say up front. You have to decide ahead of time when you are going to adjust the baselines, period.

That will create a lot of tension amongst your team. Like they have this goal post that they can see and they're stretching for. And if they are really proud of themselves for hitting it, and you feel like they hit it too soon, and so then you take it upon yourself to recalculate the baseline and roll out a new incentive plan, that is not going to go well. So you have to set expectations about when you're going to recalculate the baseline and set a new incentive in place.

Other than that, it's just about communicating openly. This is on facts, not feelings. Feelings would make you move the goal post before you said you were going to. So no, we don't do that. We stick with the plan. You make a plan, you honor the plan. And the only way that you should feel comfortable rolling out this plan is if you have played this all the way till the end, which we'll get to talk more about in a minute. But just be clear that when you're resetting a baseline, this isn't punishment. This is celebration of growth. Like we have a new normal in our firm. And you've raised the bar. This is a great thing. Now we're adjusting so that the incentives stay tied to stretch performance. 

That's the main key. And every year, we like to suggest doing the annual reviews at their workversary, not at the turn of the year. You know, a lot of people do their end-of-year reviews and raises and bonuses in December or January, and that is, that's hard on cash flow. Really, making it around everyone's one-year anniversary or their anniversary mark is a better way to go, and it helps spread the load for the firm when kicking up pay.

So you can give cost-of-living raises at the year, and that's a great time if it's an individual incentive, it's a great time to roll out an incentive plan to them. You're giving them the raise that you're going to give them, and you're giving them this opportunity with the incentive plan. So those are a few suggestions when it comes to overtime as your firm improves with their numbers, how do you keep this really healthy?

And okay, one other thing, it feels obvious, but just in case, I'll say it in case you haven't thought about this. The other reason you have to recalculate the baselines every year is because if you hold the same incentive plan, there's just more upside, more upside, more upside, more upside for the team. And it starts to get lopsided where the firm is not able to keep what is happening with the results that are being created in the firm. It's like more and more bent towards giving more a higher percentage of that to the team member.

But again, that means that you are not incentivizing on stretch, on growth, you are incentivizing on norms. And that's why you have to recalculate it because quickly an incentive plan that made sense at one point will absolutely not make sense at the next point. But you'll still keep paying it because you really didn't think this through. You didn't have a plan for this.

So you just keep having the same incentive plan even though the numbers keep creeping up and creeping up and creeping up and the baselines are higher and higher and higher and the same deal is on the table. So they're getting more and more money. That is a no. You have to, have to be willing to recalculate these once a year and reset. And if you don't, you are going to wind up in a situation where the firm is being more and more suffocated and the team members are winning more and more. That's not a win-win. That's a win-lose. So we have to find that balance and keep the balance over time of a win-win when it comes to incentives.

All right, we're going to talk about how to set up incentives responsibly. And this is all about doing the math. For those of you that say, I hear this from you guys, math is not my thing. I don't like math, math doesn't like me. I don't like numbers. This is why I went into law. Listen, you're a business owner. And the more you keep talking like that, the more it reinforces the distance between you and understanding numbers. You need to understand some numbers. You don't have to be the one that always calculates everything, but you need to understand numbers and the impacts of the numbers in the business.

So before you roll out any incentives, you have to run scenarios. The questions I always ask is, what if they crush it? What if they knock it out of the park? Does the incentive plan that you just put into place, can you afford to pay out that full bonus? And the other side is, what if performance dips? Does the structure still feel fair? So, playing out both scenarios so that you can see what happens with the numbers.

So if you have an individual bonus for an attorney, here's a couple of ideas in terms of how you can structure it. Don't take my numbers as the numbers you should be using. You have to plug your own numbers in here. And if you haven't listened to the episodes about producer cost and producer multiples, I would highly recommend going back to listen to those are producer ROI, maybe that's what it was called. But basically in there, I talk about, you have to figure out their multiple. And you do that by taking the amount of money that came into the firm that's attributed to that producer and divide it by their all-in cost.

So their salary, their benefits, the employer taxes that are paid, any money that goes towards their total compensation. So any benefits, any employer taxes, of course, the salary, incentives, etcetera. That all-in cost for that person is what you divide by. So let's say that the all-in cost for an attorney is $120,000, and they brought in $450,000 dollars into the firm, you would divide $450,000 by $120,000, and that is 3.75. So that's their multiple, 3.75 multiple. 3.75x, you might hear someone say. So, okay, good to know.

Now, when you are thinking about an incentive, you have to think about, what needs to be the case? Like, I need to see a certain amount from this individual before I even think about giving them an incentive. What is their expected, right? Like what has to be the case?

Now you will hear me talk about 3 is the floor. If you have someone that's under a 3, you need to work with them. You need to figure out what you need to give them in terms of resources or training, or probably just setting expectations and accountability to get them to be at least a 3. And when you find the number that is the minimum for you, and it doesn't have to be the 3, 3 is the floor, guys. I'm telling you. So it's not like, oh, well then everything above that is good to go. No. But this is where it just depends. It depends on your circumstances, it depends on a lot of things.

And I'm not in your firm and I can't look under the hood unless you're working with me directly. So you need to be thoughtful about this and don't just go with 3 because I said 3 is the lowest. Everything scares you, so you're going to go with 3 because that feels like asking more of the person than what they're currently doing. Really they should be a 3.7 or a 3.9 or a 4 or a 4.2. Like they should be better. But you're afraid to have that conversation. You don't trust yourself to hold them accountable. Like all of that plays into this. So don't just pick 3 because I said 3 is the floor. But I'm telling you, 3 is the floor.

Now, let's say that you calculate a baseline. You look at the amount of money that they've brought in in the last twelve months on average per month. And then the last six months on average per month, and the last three months on average per month. You average those three numbers and you tack on 10%. That is the baseline. I should say that is the baseline for someone who's at least bringing in 3 times what the all-in cost is for them. If that's happening, at least 3x, then that is the calculation I would use. Go back, figure out their baseline, and then you can start incentives above the baseline.

Now, if they are not a 3x, if they are not bringing in three times what they are paid or their all in cost, their total compensation, that's what needs to happen. And then above that can be tiers. When they start getting above a 3, then you can calculate the baseline as I've proposed. But I wouldn't do that. We're talking about expectations versus goals. They need to reach a certain expectation. If you want to put a short-term incentive in to get them cruising, to get them into a new normal that produces in a way that that is healthy for the firm, then that's fine. A short-term incentive to really get them going.

But do not put in a twelve-month plan, do not put something into place. Don't calculate their baseline and add 10%. No, they need to get to 3, period. So if their all-in cost is $120,000, then they need to be bringing in at least $360,000 into the firm every year. And that is an average of $30,000 a month. If they aren't doing that, we're not giving an incentive. 

Unless… unless you understand the person that you're working with, you understand their psychology, you want to give them a leg up. And so you are going to put a short-term incentive in place where the firm is going to win, and the person is going to feel motivated by the incentive. So you can do that. But they need to be a 3. You need to figure out how to get them to three. Then, if they aren't at 3, you need to get them to 3. If they are at 3, then you can do the baseline calculation to figure out what would be really great tier for them. So that's one way to do it.

Now the other way is if they are at a 3, at least, like they're not not healthy for the firm, right? So if that is true, then there's a couple of different ways you can approach this. One is to increase the bonus percentage after 5x ROI. So let's say, you know, if their all in cost is $120,000 and you have an incentive plan in place and there's some tiers, but after they hit five times what their compensation is, then they would get additional bonus. So that would mean that they're bringing in $600,000 that's attributed to them because of their billable work, their time on these cases, or if it's contingency fee, the fee that gets awarded to them.

Although you've got to be careful because that $600,000 isn't just on the attorney, it's also on other producers that are contributing to that. So in flat fee, you have to think about this too. But still, there's a certain amount of money that's attributed to that attorney. And so after they hit $600,000, then maybe you can give something more. Like they are knocking it out of the park for you, so you're willing to go up. So maybe they get 10% of everything that's collected over $600k in a year. That's a huge win. So they have baselines, and they have tiers set up for above the baseline. And then once they hit a certain threshold, then you're willing to give a percentage of what's collected above that threshold. And you could do that after a 5x multiple and feel pretty darn safe and great about it.

Now, I sort of skipped between, like when you set the baseline, what does that look like? I have always been a fan of a dollar amount, not a percentage tied to those first levels that they could reach with incentives. So let's say their baseline is $33,000 a month. Like, their true average was $30,000, but you're going to add 10%. We don't incentivize for normal. So they have to hit at least $33,000 a month, in order to be eligible for an incentive. That's $30,000 a month, plus 10% of $30,000 a month is $33,000 a month. Okay, so let's say that's the baseline. 

Now, having tiered structures with dollar amounts attached to each tier is a great way to go up to a certain point. And you could just stop there. You know, I gave the idea of once they're above a 5x, whatever that number is, then maybe you kick in, and it's like a 10% of all collections above their 5x. But the tiers that I'm getting ready to share that are right above the baseline, those are the most important to nail down. And having dollar amounts attached to a tier instead of a percentage attached to the tier can help. It can be protective for the business.

It's much more predictable when they hit a range that they're getting a certain dollar amount instead of a percentage. And you can still do it in a great way that feels good to the team member. So let's say that maybe the first tier is $33,000 to $38,000 in a month. And if they hit within that range, let's say as an example, they get $650 extra in incentives for hitting that range. Now, you could calculate what the percentage is on that, but it's more about stopping and thinking like, okay, if they hit $33,000, they are beating what their norm was. That's the baseline, right? It's the true average plus 10%. So they're already doing 10% more than what their normal was.

So that's good. Like if you want to reward that behavior, that's good. Now, if they brought in 10% more than what they used to do, all the way up to, let's say, you know, $5000 more dollars in a month, then if they're somewhere in that range, they're getting $650. That's the deal. If they are between $38,001, I'm just I'm pulling these numbers out, but this is something that I would play out in a spreadsheet to see what I think, then $38,001 up to $45,000. If they collect that in a month, they get an extra grand. Not $650 plus $1000, they just get $1000 for hitting that tier. So the tier that they hit is associated with a dollar amount and they get one dollar amount. And it's associated with the tier that they hit.

I'm making sure that I say this so that you guys don't think, oh, well they blew by the first tier, so they get $650, plus they get $1000 because they're in the second tier. No, they just get $1000 because they hit the second tier. So you can imagine if they did this every month, they'd get $12,000 a year. You may not like this. This may not make sense for your firm, these exact numbers. But that's why I hesitate on doing these episodes.

You have to play around with this. And the way that I like to do it is to put it in a spreadsheet and say, okay, this is their total pay, their total compensation. This is what is their baseline, and I'll put that number in. So in this case it was $33,000. And then I'll have the next column will say, if they hit this tier, they will receive $650. Like that's what I'll try to put in. I would test it in the spreadsheet. So $650. And then next to that, I would put, what does that make their total compensation? And then next to that, which you could just make one column that calculates the multiple, I would calculate what the multiple is.

What it would be if they hit on the bottom end of that and the top end of that range that you're giving them. And just put those numbers there so you can see, oh okay, that means that they were this multiple. If they are to hit this tier in that month, they would have been this multiple on the low end, this multiple on the high end. Okay. And then if they hit this tier, tier two, which is between $38,000 and $45,000 a month, then this is what their total compensation would be for that month. And this is the multiple that that would mean for that month.

So I would play this out and just make sure you're protected. If it starts dipping the wrong way, if your numbers don't play out and where, you know, they were a 3 on the dot, and now because of the incentive, they're actually a 2.9 now or 2.8. Nope. That doesn't work. It's not good for the firm. That means you're dipping in territory that it's no longer a win because the multiple is going down for the firm. You need the multiple to continue to raise as they get incentivized. I'm hoping this makes sense.

So that's what I mean by do the math, play this stuff out. I'm giving you one scenario of the type of incentive you could put into place, which is you calculate their baseline, and then you set up tiers with a dollar amount to a dollar amount. And if they hit in that, then they get this dollar amount. It's a flat fee. That is one way to do it. Now, you could do that all the way up until it's 5x.

So in this case, if they are making $120,000 a year as their like all in compensation before incentives, right? This is before incentives. Then that would be $600,000 in a year of production would be 5x, except here's why I told you in the spreadsheet, you know, if they hit this tier, this is what their compensation becomes. When you calculate that multiple, you just need to make sure that it's healthy. But as they earn more, it's harder for them to hit 5x because they're earning more. Their all-in cost is going up as you're paying out incentives. Do you see?

And it's a win for everybody, so it's not a problem. They can't just hit $600k anymore because on the way to $600k, you have said you're going to reward them for tiers that are on trend for more than their baseline. So you're giving them more money to go above and beyond what their norm used to be. And when you do that, it means that you're paying out more.

So that's why in the spreadsheet, if you can have their compensation, total compensation, and then what's expected out of them, right? Then you could do the multiple that what's expected is $33,000 a month based on what we've talked about. So then you do the multiple on that. And it's 3.3. That's the multiple. If they hit their baseline and this is what their compensation is right now, that's a 3.3.

Okay. But now if we put in this incentive in place, and we say, okay, but if they hit somewhere between $33,000 and $38,000 dollars in the month, we're going to give them $650 on top of their regular compensation. So then for the month, because it was $10,000 a month you were spending or investing in that producer, but now you've added $650. So if they hit that tier, you're going to be paying out $10,650. And they fell in that tier, right? That $33,000 to $38,000.

Let's say they hit $35,000. So what you would do for that month is say, okay, they brought in $35,000, I paid out $10,650. So $35,000 divided by $10,650. That's a 3.2, almost 3.3. So it doesn't really change that much. So that's fine. Now, let's say they hit $38,000. So $38,000 divided by $10,650. That's a 3.56. Okay, that's more. That's good. So they're at the top end of that tier, and their multiple went up, right?

So you could see why in your spreadsheet, you should calculate the tier and the dollar amount that they're going to get. So what does that put them at for the month in terms of compensation? And then do the multiple. Do the math to figure out, oh okay, so if they hit on the low end of the range they would hit this, and on the high end of the range they would hit 3.56, what I just shared with you. Okay.

So then the next tier up, let's say they hit the next tier, and if you do use the $38,000, or $38,001, to $45,000, and you are going to pay out $1000 for that tier. Okay, so on the low end of that tier, they still get $1000 extra. So that is $11,000 of compensation that month because it was $10,000 normally, but you're giving them an extra $1000 because they hit this tier. So $11,000 and they hit $38,001. So I divide $38,000 divided by ,$11,000 and that's 3.45. Okay, so on the low end, if they hit that tier on the low end, they are 3.4, almost 3.5 multiple. On the high end, if they hit $45,000 and you're paying out $11,000 that month, they are a 4x. That's great. That's super great. That's super healthy. And everybody's winning.

They are getting a reward for stretching above their baseline, and they're getting an extra $1000 a month if they hit that tier. That's $12,000 a year. That's not insignificant. Again, this depends on your firm. It depends on the kinds of case work. These numbers are totally made up to be an example, so you can see how this will work. It is your job to sit down and plug in numbers that make sense for your firm. Plug in the salaries that the total compensation that you are spending on the producers, and what they're bringing in. Like you have to figure this out. I'm just trying to lay out an example for you.

So now, let's see what the next tier. If we did, you know, $45,000 to $52,000, if it was somewhere in that range. Let's say you were going to give $2000 to them if they hit this tier. Well, if they're on the low end of the tier, it means that they are a 3.75 multiple. It means that they brought in $45,001. And you're going to pay them an extra $2000 because they hit that tier. Then that means their normal total comp is $10k a month all-in cost, plus you're giving them two thousand extra dollars. That's $12,000. So we're going to take $45,000, the low end of this tier, divided by $12,000, and that's 3.75. Okay, still healthy.

If they hit the high end of the tier, so it's $52,000. It's a 4.3x. Okay, that's great. So you can see how you keep going up in these tiers. And where people start to make mistakes is when they don't keep a watch on the multiple as the numbers trend upwards and they're paying out more and more and more and so they're driving that person's multiple down because of the deal that's on the table.

And so, if I didn't do it this way, if I didn't calculate the multiple that they're at at every stage and what that means at every stage with their incentives that are going out, I could easily get myself in a situation where the payouts are way too big, way too big to the team member. And it's just because we didn't do the math along the way. We didn't really play out the scenarios all the way to the end.

I think you guys get my point there. And you could keep creating tiers and attaching a flat rate associated with that tier. Do the math, make sure it makes sense, make sure their multiple stays healthy at every tier on the low end, and if they knock it out of the park. And you could see very quickly how their compensation can really raise because of these incentives, and the business is protected.

So this is very different than just giving a big raise. If they hit the last tier that we talked about, every single month, that's $2k a month. That's $24,000 in a year. And if for someone who's making a $120,000 all-in compensation, so there's that all in compensation plus $24,000 in a year, that's a 20% raise, but you're not giving them a raise. You're not just giving them the money, no matter what, you're giving them the money if they can do their part to keep this business really healthy and thriving.

So they are in a growth phase, and they're getting compensated for that growth. And it really allows everybody to thrive. That's a win-win for the employee, heck yes, and for the firm, heck yes. So you can imagine if they're making $24,000 on the low extra in a year because you're paying them out $2000 every month, which may or may not happen. Again, everybody is so different. Every firm is so different. I don't know the psychology of the people that work for you, but this is very doable, right?

For many people, this is doable. So if it's an extra $2000 a month that you're paying them in an incentive, that means they're at least hitting $45,000 in a month, and their baseline was $33,000. So if they're able to do that, that is an additional $12,000 over their average, plus 10%. So if they're hitting $45,000 every month, and so they're eligible for that $2000 incentive, that means they're bringing in at least, this is on the bottom end, at least $144,000 more dollars that year than their baseline. And you are paying out $24,000 to see that $144,000 come in. You are rewarding, giving an incentive of $24,000 for that. It is a win.

That is not insignificant to the attorney. So it is significant for the attorney, and it is significant for the business. It is a win-win. So if they were able to do that, they are bringing into the firm for the year $540,000. And you're paying them $144,000. And that's a multiple of 3.75. That's great. You can adjust these numbers so that the multiple is 4 or 4.2 or whatever makes sense. It really, really depends on where you are, the type of firm you have, etcetera.

But just doesn't really matter as long as it's healthy, right? As long as it's healthy, and people don't stop to check to see if this is healthy. They don't check the multiple. They just shell out cash. In their head, cash is coming in. I'm going to… I'm happy to pay them cash. Yeah, but you're not thinking this all the way through. You have to do the math. I know it's not fun. I know a lot of people don't like it. It doesn't matter if you don't like it. You will do harm to the firm if you don't play this all the way through.

I should say one more thing. The reason I like this dollar amount for the tier, not a percentage, is because they could really go for a tier. Like going for that tier and hitting it is so great. There's something motivating about it. People around them, you can rally around them. Like, you're you're going to hit tier two this month. This is incredible. Good job. Let me know how I can support you, etcetera. Like there's something about hitting that next level. So that's why these can be really motivating and really fun. And they have control over it. They can exercise as much as they can in order to be in line with it, which is really cool.

You can also do percentages, if you really want to. I know percentages is like a really common way to do things, but I hear the percentages that are being spit out. It's so high. Most of the time it's way too high. You could say for again, someone who's total compensation is $120,000, you could say, okay, they need to be at least, you know, hitting $360,000 or $375,000. You could decide the floor. Anything above that, I will give them 10% on collections for anything above that amount up until $600k. And then at $600k, it changes. I'll give them 15% of collections above $600,000.

You can do something like that and play that math out until the end, see if that feels appealing. Does it feel like a win for both parties? Not just one party. Again, I don't love the percentages. It's almost like a commission or something, like there's just this expectation of money coming their way if they're above a certain amount, and it's just percentage-based. Lik,e entitlement happens more of the time with percentages than it does with tiers and flat fees associated with the tiers.

We could dig into why, in terms of psychology, it is true. I see it all the time. So I don't like percentages in this way. I'm not saying there's not a certain time and a place for it, depending on the kind of firm that you have and depending on the kind of team member that you're dealing with. But generally speaking, it produces entitlement.

But I never find anything wrong with above 5x. Like when they cross the threshold of bringing in more than five times what they are being compensated with, and that includes incentives, then it really allows the business to open up and give them more. So you really could have a percentage above that because they are really they're doing a great job for your firm if that's where they are. So there's more upside that you can give to them. So it keeps the early bonus modest and sustainable, but it's real upside as they scale. And it subtly teaches them the business.

You know, like if I produce $800k, I'm worth more. But it also means I'm wildly profitable for the firm. That's a good spot to be in and I get to share in some of that. There is a percentage associated with anything above that above 5x because I'm really bringing value, and they can share the value at that point with me. So it teaches people on how to think about the position that you're in.

And the last thing, you know, with all the examples we've talked about, it's rooted in real economics. You know, after they cover 3x, 4x, 5x of their cost, the margins widen enough to justify a higher reward. And so, you know, I'm a fan of the tiers with the flat fees, but however you stack this, that's true. 

When they are not producing at least 3x, there is no chance that your firm feels a bunch of breathing room inside in terms of the health of the business. For sure, cash flow feels tighter than you want it to. Your profit margins aren't as high as you wish that they were. Like that's what happens when people fall below a 3. Above a 3, you start to actually feel breathing room. 3 is sometimes people don't feel it there, but it certainly can't happen below a 3.

But typically, 3 and up is where you start to really feel like, okay, now we can do things that we want to do. We can set aside money for savings. We can invest in this new team member that we've needed, it has just been too tight to get them. And so it's like everything opens up for you. You can do these incentive plans, right? So it's just important to play the math out all the way to the end.

This is a long episode. Okay, so closing things up. I'm hoping this gave you food for thought. I hope this helps you realize where you are with things, whether you are involved in an incentive plan right now with your team members that's just not working for the business, and you need to figure that out. You need to push a reset button because it's going to be so hard to climb out of whatever hole is being created with this. Or whether you wanted to put an incentive plan in place, but you're unsure how to approach it, it feels too messy.

Take your time with it. Don't just rush into something. Really use this episode to, you know, you can listen to it over and over again and just kind of think about your own situation, think about how you would set up the spreadsheet. And yeah, use this. Use this as a tool, as a voice of reason, so to speak. Really do the math and make sure that your business is protected, that it's a win for the business and a win for the person that's involved with the incentive. And remember, just like we talked about last week, you can do group incentives, you can do individual incentives, you can do a combination of both.

But I mentioned this last week, and I thought about it more after the episode. So I'm going to just mention a couple things here. When the team is smaller and everybody is really working together to make results happen, a group incentive can be great when the team is tight and everybody is like playing hard on the field. And then as you go along and as growth happens, it typically makes more sense to branch out towards individual incentives.

And part of that is because as the team grows, sometimes things can be more watered down, even if you don't want them to be. There may be a team member that's not pulling their weight as much as others and that can create resentment. But also, people have direct control over very certain thing,s and you should incentivize them on those things that they have direct control over, not just when the team wins, we win.

One of the firms that worked so hard on the incentive structure that I told you about, what they realized is they had like a whole firm incentive. Everything needed to be hit in order for this incentive to be paid out. There's details there, but that's all you need to know. And what they ended up doing was breaking it up by department. So if this department, if they hit their numbers, they get their incentive, not the firm has to hit the numbers, just that department has to hit the numbers. And that is… really invigorated the team and they can see control, they could see their path to being incentivized no matter what the other departments are doing. And then what they have realized is they actually think that the next time that they make adjustments to these incentives, they're going to do it individually, not by department.

So you could see how the bigger that you grow, the more it might make sense to get more individualized. With a smaller team, the more it might make sense to have a group incentive. But that's the beauty of this. Like these things have to morph, they have to change. The mindset and psychology changes as the business grows. The set of circumstances changes as the business grows. And so if you aren't in tune with that and you just stick with what you've always done, you'll start to feel something go wrong, whether it's an attitude problem from the team, or whether it is frustration because people aren't carrying their weight. Like it'll start to fall apart. So you have to really be in tune with it the entire way.

And I think we should end on, like the last thing I'm going to say, is that what you incentivize will multiply. And how you incentivize will determine if it multiplies or not, because it should. It really should. Incentives are a leadership tool. They tell your team where to focus. And healthy incentive structures don't just drive performance, they build a stronger culture. If it's an unhealthy incentive structure, the opposite will occur.

There's never neutral ground with incentives. It either motivates and gets people working and facilitates the behaviors that are really important for the health of the firm, are really important for the clients, for the cases, for the team members, for the owner, for the health of the firm because for the health of the firm, all of those different parties that I just named, all of that wins when the health of the firm is taken seriously. And incentives can be a really great way to do that.

So healthy incentive structures, and that's why I tried to do these two episodes is to give you a read on health, what is healthy? How do you know if it's healthy? And when you put these things into place, if people have a certain attitude about them, if there's a vibe that's not good, one of my favorite quotes is, “where there's tension, there's a missing conversation.” 

So what conversation do you need to have? And be open and be supportive. Be a true leader in those scenarios to find out what's not sitting well here? Like why is the attitude here? These are put into place for all the right reasons. If you're having barriers getting to those levels and being able to reach your incentives, how can I help you? Because this is possible. I've played it out. We're doing it based on growth, 10% growth is where it starts from what your normal is. So what can I do to help you?

Or if they aren't even at 3x yet. Not all incentives are tied to producers, but there's other incentives in the firm that can make sense. But if it's a producer and they're not at 3x even, then have that discussion about, what is it going to take to just to hit the expectation of being here. And part of that maybe because you didn't set expectations prior, but now here you are, and you have a chance to show up for this business in a way that's going to serve everyone in the long term. So it's having an uncomfortable conversation, experiencing discomfort now for the long game, for what's best and healthiest for the firm.

Don't avoid that. Where there's tension, there's a missing conversation. Have the conversation and be supportive in it. What do they need in order to knock their job out of the park? Because you are down and you want to help them do it. You want to see them reach these incentives. You want to see them thrive because you know because of the way that you've put this incentive in place, it also means the business is thriving, which means that your clients feel that. There's a ripple effect to that. And you will as an owner as well. You can do things and invest in your team and beyond.

So I hope that these couple episodes, if you are considering incentives, you will really think this through and take it seriously. Go slow with putting these together because once they're rolled out, it's really hard to pull them back in and say, never mind, that doesn't work anymore. We didn't realize that wasn't going to work. That's not the healthiest thing for the firm. That's not ideal.

And also just remember, you don't have to have an incentive program in your firm. You don't have to have it set up. You can, but approach it slowly. But it's not a requirement. I work with several firms that they don't have incentive structures, but they pay fairly, and it does make sense from a multiple perspective. People are happy and thriving and there's no incentive structure. So you don't have to have it, but if you're considering it, I'm hoping that these two episodes help a lot.

And remember too, I mean, I think some of the reason that incentives that I see that are so unhealthy is because people came from Big Law and they're putting Big Law types of incentives or incentive structures into place. You are a small business. You are not a big law firm. You are a small business. You have to be smart, be fair, be clear, and plan for sustainability. And putting in a structure that worked for a company that's much larger into a small business, it's not going to go well. It doesn't fit. Different structures will fit at different phases of your business and with the growth of your business.

So be responsible with that. Don't just take what you see someone else has and put it into place. No. You have to do the math all the way through and figure out what makes the most sense for where you are, where your team is, and where the business and the health of the business is.

All right everybody, have a wonderful week. I'll see you here next Tuesday.

Hey, you may not know this, but there's a free guide for a process I teach called Monday Map/Friday Wrap. If you go to VelocityWork.com, it's all yours. It's about how to plan your time and honor your plans. So, that week over week, more work that moves the needle is getting done in less time. Go to VelocityWork.com to get your free copy.

Thank you for listening to The Law Firm Owner Podcast. If you're ready to get clearer on your vision, data, and mindset, then head over to VelocityWork.com where you can plug in to quarterly Strategic Planning, with accountability and coaching in between. This is the work that creates Velocity.