A compensation agreement ensures that an individual will get paid for the services he or she provides to a company as an employee. This document is often used for those who work on commission and those in high-level positions who receive a combination of executive salary, stock options, performance bonuses, and other benefits.

Elements of a Compensation Agreement

The compensation agreement delineates the terms of an individual's employment with the company, including when an employee is newly hired or receives a raise. Contract employees are generally not used for at-will employees. If you are asked to sign a compensation agreement by a new company, review it carefully to make sure you agree with the stated terms.

In most cases, a compensation agreement is used in conjunction with an employment contract. It includes details such as:

  • The form and amount of compensation
  • How often wages will be paid
  • The terms of performance incentives
  • Bonus information if applicable

It's especially important to have a detailed compensation agreement if you are paid on commission. This type of contract should include:

  • How commissions are calculated
  • Gross profits
  • Payment periods
  • Sales
  • Revenues

Contracts should include specific, clear language along with definitions of legal terms or other jargon that may be unfamiliar. In many cases, the contract will note that the worker is employed at will. You may want to have an employment attorney review your compensation agreement before signing.

In cases in which an employee can take a draw on commission, these terms must be clearly dictated in the compensation agreement. These details should include the repayment schedule, maximum draw amount, and procedures if the employee quits, is fired, or becomes disabled.

If employees are offered special benefits or perks, such as extra vacation time, stock options, a company car, or stock purchase programs, these should be detailed in the compensation agreement as well.

Advantages of Employment Contracts

Tools such as compensation agreements and employment contracts allow you to control an employee's ability to leave the company. A written contract can establish a definite term of employment or require the employee to give a specific term of notice before resigning, such as 90 days. This can also specify a penalty for not abiding by these terms.

You can also include a confidentiality clause in the employment contract if the employee will be exposed to sensitive company information. This will prevent the employee from using this data for personal gain or sharing it with people outside the organization.

If you want to attract a skilled employee who currently works for another company, an employment contract can be used to craft a compelling offer with benefits such as job security and bonuses.

The employee agreement can also specify productivity goals that the employee must meet and establish grounds for termination.

Disadvantages of Employment Contracts

Employment contracts limit a company's flexibility to change the terms of employment if they no longer fit business needs. To change a contract, you will need to negotiate new terms with the employee, and he or she may not necessarily agree.

Employment contracts also require employers to act in good faith. If the employee feels he or she is being treated unfairly and the courts agree, you may need to pay legal damages for violating the contract.

Common Employment Contract Terms

  • Non-compete clauses prevent employees from working for a direct competitor within a designated geographic area for a specific period of time, such as two years.
  • Intellectual property (IP) ownership clauses are used with employees who invent products for the company. They state that any inventions created at work and for a set time after employment termination are the property of the company, that the employee will cooperate with the patent process, and that royalties will be assigned to the company.
  • A best efforts provision indicates that the employee will work hard on behalf of the company.
  • An exclusive employment clause means that the employee will not work at another company in the same or similar industry at the same time.
  • A no extra compensation clause indicates that the employee will not be paid extra for serving on a board or committee.

If you need help with creating or negotiating an employment compensation agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.