Compensation Agreement

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What is a Compensation agreement?

A compensation agreement is a legal contract created in addition to an employment contract. It outlines complex compensation packages and is often used for employees who work in high-level positions.

Unlike an employment contract which usually includes a simple section on salary and benefits, a compensation agreement breaks everything down in a legal contract between employer and employee.

Suppose you are hiring commission-based employees or employees for a high-level position that will earn a combination of bonuses, a stock incentive plan, and other forms of remuneration in addition to their salary. In that case, you probably need to add a compensation agreement to their employee onboarding package.

What is Included in a Compensation Agreement?

As a legal contract, a compensation agreement starts by naming the parties involved in the agreement. Other sections that may be included are:

  • The various types of remuneration that will be paid to the employee and how often it will be paid
  • How bonuses and performance incentives are calculated, and when they will be paid
  • When and how commissions will be paid
  • Definitions for gross profits, sales, and revenue if there is a profit sharing or commission structure
  • Information about stock options that might be available to the employee, and if there is any vesting period, how long it will be

Depending on the terms of the compensation agreement negotiated by the employer and employee, there may also be additional information included.

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Purpose of a Compensation Agreement

The purpose of a compensation agreement is to formalize complex remuneration packages into a legal contract so that all parties involved understand when and how various types of payment will be earned and paid.

This helps ensure that the employee has a detailed document they can refer to and understand the details of the remuneration package.

It also ensures that employers are legally protected from disputes about payment because all parties can refer to the compensation agreement when a question arises.

Because both employers and employees use compensation agreements for reference purposes, they must always be up to date. So when a particular employee’s role or remuneration package changes, their compensation agreement should be updated too.

This means that companies and employers do not have to amend the employee’s employment contract when there are changes to compensation. Instead, they can simply reference the compensation agreement in the employment contract and update it when necessary.

Here is an article to learn more about remuneration.

Types of Compensation Agreements

There are various types of compensation agreements for different kinds of employee contracts that might be offered to employees. Usually, compensation agreements are used when the compensation package is complex and multi-faceted. Still, it could be any of the following or a combination of several:

  • Straight salary
  • Salary plus commission
  • Salary plus performance bonuses
  • Commission only
  • Salary plus profit share
  • Salary plus stock options
  • Non-monetary compensation, such as paid time off, company vehicles, and other perks that are included in the package
  • Signing bonuses, if applicable.

In many cases, some types of compensation an employee will earn will be subject to conditions. So, for instance, an employee might only earn a commission on sales or revenue above a certain predetermined value. Or, they might only be entitled to own stocks after they have been with the company for a specific time.

Compensation agreements include other information, too – like penalties for employees who resign before being in a position for a specified period.

It’s very important that employees given a compensation agreement read them carefully and become familiar with all of the terms of the agreement.

Here is an article about compensation and benefits.

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Who Uses a Compensation Agreement?

Compensation agreements are typically used for employees who are in high-level positions and who will earn a larger remuneration package.

These agreements are used to ensure that there is a legal contract that stipulates their exact earnings package, including all information about:

  • Salary
  • Commissions
  • Bonuses
  • Stock options
  • Benefits

A compensation agreement is usually unnecessary when employees earn a simple salary, and a standard employment contract would suffice.

Here is an article to learn more about a standard employee contract.

How Do You Write a Compensation Agreement?

Since a compensation agreement is a legal contract, it must be adequately written by someone familiar with employment laws in your area.

It’s important to note that in most places, compensation agreements and employment contracts cannot remove fundamental employee rights, even if they are signed and completed. So it’s important to ensure that your compensation agreement aligns with local laws and regulations.

Compensation agreements are usually written after salary and compensation negotiations are completed and are used to turn the results into a legally binding agreement on both parties.

Compensation agreements usually follow a specific template, starting with both parties' names and contact information. They then set out each type of compensation that will be paid, along with all relevant terms and triggers.

For a compensation agreement to be a legal contract, it must also be signed, dated, and witnessed. The employer will retain the signed original, and the employee will usually be given a signed copy of the document for their records.

Compensation agreements usually require legal advice and assistance, which can add to the cost of onboarding employees. So it’s generally not best practice to provide every employee with them. Instead, they are usually reserved for high-level positions with a larger compensation package.

When and How Might You Refer to A Compensation Agreement?

In most cases, neither employers nor employees will be required to refer to a compensation agreement regularly. However, in cases where there is a dispute about an element of remuneration, or if the employee’s remuneration package is incredibly complex, it is a valuable resource.

Your accounting department will also use compensation agreements to calculate and pay various employee benefits.

Finally, suppose there are clauses about payments made on termination of employment or any penalties that either party might pay. In that case, a compensation agreement can ensure no disputes or confusion.

Get Help with A Compensation Agreement

Like many legal contracts businesses use, most hope they will never have to use these kinds of agreements in a legal setting. However, it’s always better to have them and not need them than to need them and not have them.

There is a good chance you might never have to use a compensation agreement to settle disputes and legal action by employees. Still, if you do, it can help prevent long, costly, drawn-out cases. That alone means it’s an excellent investment for most companies.

Understanding employment contracts can be tricky, and compensation agreements are no different. So if you’re hiring employees who will earn a significant remuneration package, it’s a good idea to use a legal specialist who understands employment law.

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