What is a Bonus?
A bonus is “a form of compensation that is not guaranteed and that is usually paid after the completion of a certain event,” says Adi Dehejia, The Muse’s Chief Financial Officer.
Bonuses come in many shapes and sizes (all of which we’ll explain later), but generally speaking, they’re performance-based, meaning a company distributes them based on how an employee or group of employees contribute to the team or company goals—typically revenue-based ones.
That said, a lot of bonuses are discretionary, meaning rather than the bonus being tied to a specific quota, your level, or your performance, a manager simply gets to decide who is and isn’t worthy of one, as well as how much the bonus is.
As you can imagine, this makes bonuses a pretty complicated subject for companies and employees alike.
Bonus vs. commission
Both terms refer to payments that employers make to employees on top of basic wages and salaries.
However, commissions are usually based on the employee’s performance, while bonuses are based on the business’ performance.
This is not a strict rule. Sometimes people get bonuses because they performed well. It depends on how a company uses the term.
Put simply, bonuses may relate to either the employee’s or company’s performance, but no commissions. Companies only pay a commission when an employee has performed well.
In other words, the term ‘bonus’ may mean ‘commission,’ but ‘commission’ never means ‘bonus’ when it refers to the company’s performance.
“Commission and bonuses are payments made on top of basic wages and salaries.”
“Commission is generally based on the performance of an individual or team and are commonly applied to salespeople, whereas a bonus is more likely to be linked to the performance of your business over a certain period of time.”
2. Why Do Companies Provide Bonuses?
Often bonuses are provided because that’s what the market tells companies to do. If other organizations of similar size, industry, or geography are offering their employees bonuses, a company may feel obligated to do the same to compete for good talent. This is why you’ll rarely find a sales role without a bonus structure.
They also want to hire people who they know are going to perform, and when there’s a reward for output you’ll attract a certain kind of person.
But the main reason employers are drawn to bonuses is because they encourage employees to work hard to help the company succeed. “They want to align incentives—like, ‘You do well if the company does well,’” says Dehejia. And it tends to pay off—people who know they can make more money by bringing in more revenue, whether directly (like sales) or indirectly (like marketing or executive leadership) are going to be highly motivated to do so.
“They’re trying to share the risk between the company and the individual,” adds Dehejia. When a company does poorly because of poor performance, the employee pays the price with lower compensation—as opposed to someone with no bonus structure who gets paid the exact same way no matter how well the company does.
Some people may find this concept stressful. But the flip side—having a yearly salary without a bonus—means there will be times where you work extra hard and aren’t compensated for that work. It’s a trade-off, and one certain people are willing to make.
Dehejia notes that bonuses are never meant to be the sole driver of employee retention and motivation. Compensation is one means to drive performance, but “it doesn’t substitute for management, [and] it doesn’t substitute for praise, learning and development, training, [and] opportunities,” he says. That’s why companies should always be thinking about the value of their bonus plans and balancing them with other perks and benefits.
3. What Types of Bonuses Are There, and How Do They Work?
Some bonuses are distributed quarterly, others yearly. Some are a one-time thing, others are recurring. It all depends on what role you’re in, what level you’re at, what you contribute, what your leadership is like, and what kind of company you work for (among many other things).
An annual bonus is usually based on overall company performance. So you may get a large or small bonus (or no bonus at all) depending on how successful your organization or specific department was that year, as well as how big a part of that success you were. This can also be considered “profit sharing.”
The reason companies wait a full year before paying you is simply because it means you have to stick around longer—which is why very few people leave their jobs before collecting their yearly bonus. It’s also, again, tied to company goals, so they want to ensure they’re driving performance for all 12 months, not just a chunk of the year.
A spot bonus is for people who go above and beyond and is “usually tied to a task that was outside the scope of your role,” says Dehejia. If, for example, you helped out with a special project, worked extra hours, or played an integral part in the company’s success in an unexpected way, your manager can use their discretion to offer you some additional compensation. It’s normally a one-time thing, if not an occasional occurrence depending on budgeting, priorities, and your leadership.
A signing bonus is a one-time bonus provided when you sign on to a new role. Companies might offer it when an employee is walking away from something better, or if the employee is moving to a new city for the job and the company wants to cover some of the costs (this could also be in the form of a relocation bonus or package). It’s also a way for employers to make up for salary demands they can’t meet. Basically, it’s to incentivize candidates to accept the job.
“And then generally speaking there’s a clause in your employment contract...which says that if you leave before a certain amount of time, typically a year, you owe the money back to the company,” says Dehejia. Unfortunately, it’s hard for companies to enforce this. The risk that companies take is hoping that the bonus actually gets you over the first-year hump and encourages you to stay on longer.
A retention bonus, similar to a signing bonus, is about retaining valuable talent. It’s typically provided during an acquisition, merger, or big company restructuring to convince someone to stick around for an extra period of time, if they were looking to leave or have a competing offer elsewhere.
“Retention bonuses are really paid on the backend,” explains Dehejia, meaning you don’t get it until the time period is up.
A referral bonus is meant to encourage current employees to refer great candidates for jobs at their company. It’s typically not given until the candidate is hired and has stayed on for several months.
The bonus itself, Dehejia says, has to “be interesting enough that you actually refer someone,” so it’s usually a good amount of money depending on the job and level—anywhere from $1,000 to several thousand. “Sometimes they just do [a] flat [rate] for every role, some companies do a higher amount for roles that are harder to fill,” he adds.
Also known as a “13-month salary” or “Christmas bonus,” a holiday bonus is another way to recognize employees for a hard year’s work and to give them an extra boost during an especially expensive time of year. It’s a lot more common for companies based outside the U.S. It’s often—but not always—a set percentage of your annual salary, say anywhere from 5% to 10%.
Like bonuses, a commission is considered “non-guaranteed compensation,” but legally they’re often defined separately, and they work slightly differently.
The commission is about individual performance. Tons of jobs work under a commission structure (like sales, account management, real estate, finance, and recruiting, to name a few) and payment can be distributed monthly, quarterly, or yearly, depending on the plan and when commission is considered “earned.” (For example, “earned” may be defined as when a client signs a contract, meaning that the employee who sold the deal won’t get their commission until a signature is collected and the deal is verified.)
A commission can be a set percentage—say, a recruiter gets an amount equal to 15-20% of their hire’s first-year salary—or can be defined by a formula, the idea is that everyone at the exact same level has the same formula. This makes it easy for companies both to measure success and hand out compensation and avoid being accused of favoritism.
Your commission is generally tied to a quota or goal, which can be a dollar amount, a number of items sold, or a number of closed deals or booking meetings. The idea is that if you get to 100% of your quota, you’ll earn 100% of your commission.