How to Set Salaries Determining what to pay your employees doesn't have to feel like a calculus test. Follow these tips for setting fair and equitable rates that won't break the bank.

Setting salaries for your staff is always a tricky thing to do. It's especially hard if you've never done it before, because you probably don't even know where to start. On the one hand, you want to pay enough to get the best possible talent. On the other hand, you don't want to overpay. What's an entrepreneur to do?

First of all, don't panic. Remember that your goal is to attract good talent and pay them fairly. When it comes to the exact amounts you should pay, however, know this: You never want to pay more than the job is worth to you. That's just good business. Because at the end of the day, a salary is like any business expense--it's an investment, and you should get a return. So you begin by deciding the top amount you'd be willing to pay.

The best way to determine that ceiling is to ask yourself this: How much more valuable will this person make my company? Your answer is the most you'd be willing to pay that person when it comes to their salary.

For a salesperson or business development employee, that question is easy to answer. These type of employees bring in revenue, so you can just ask yourself if the sales they're generating covers their salary. If your new sales candidate can bring in $500,000 in profits, then it might certainly be worth it to offer a $200,000 salary plus commissions to bring them on board.

But how do you decide what you'll pay for administrative and support staff? The ones who don't bring in money but whom you couldn't live without? Their value isn't so much in the money they make but in the money they save. So ask yourself what it would cost not to have them on board, and use the answer to justify their salary.

Consider your IT person, for instance. If you had to configure your own Windows network, how much time, effort and money would that cost you? Be sure to add in your therapy bills, divorce settlement and the stitches you got from throwing your monitor through the plate glass window of your office. Then multiply that amount by the number of people in your company. Now you know the real value of your IT person.

When calculating what a job is worth to you, you might discover a position isn't worth the money you're actually paying. For instance, your new $50,000-a-year front desk receptionist may be the world's best receptionist, but you just don't find enough value in that position to justify the salary. So when it comes to rehiring for open positions, if you know a job's value, you can quickly eliminate candidates who are too expensive. (If you disqualify everyone who's asking too much, however, it's a sign you're either under-valuing the job or you should just do it yourself.)

Determining the Bottom of the Scale

So now you know the most you'll pay. The next step is to figure out the least you'll pay. And that's where the market comes in. Market rates set candidates' expectations. Sometimes, the market underprices value. Truly excellent knowledge workers do ten times the work of merely good ones, but they're only paid 20 to 30 percent more. Other times, the market overprices value (can you say "Fortune 500 CEO salaries"?). Either way, candidates will expect you to at least pay market rates unless you can offer good alternatives. Check out Salary.com for salary ranges sorted by position and geography. You'll find out what's high, low and average for your state and town, so you can begin any employee search knowing what candidates will expect.

Other business owners are a good source of pay scales, because they can share their market rate experiences. Call members of your local chamber of commerce, or join a business networking group where you can schmooze with other business owners and swap salary data. For administrative jobs, call your local temporary staffing agency and price out a temp. Then figure the salary for a permanent position from there, taking into account that you won't be paying agency overhead, but you'll be providing benefits. For high-level jobs, headhunters and recruiters are great sources of information. They'll often provide some guidance for free in the hopes that you'll hire them when you need a formal search.

At the end of the day, you'll pay a combination of what the job is worth to you and what the market demands. It's also critical, when it comes right down to it, to consider each new hire individually. As much as we all love salary bands, you shouldn't let the standard process blind you to the need for exceptions. When you're hiring a salesperson with close personal relationships to your five hottest prospects, feel free to pay way above market. I sure would.

Deciding How You'll Pay

So once you know what the job is worth and what your candidates will expect, you've got to decide how you'll pay. Will you offer a fixed salary or hourly pay? Sometimes the choice is yours, but often, there's a common perception among employees that certain positions will pay one way or the other.

While salary-based jobs are typical for managers and white-collar positions, hourly pay is traditional for temps, some consultants and certain blue-collar jobs. Hourly pay is natural when the work is directly related to time. For instance, assembly line workers are paid hourly because their productivity is directly related to hours on the line. Ditto for retail clerks. You might think a retail owner would be paying for great customer service. But that's only partially true. While treating customers nicely certainly makes a difference, a clerk who isn't at work can't deliver that great customer service, so they're stuck being paid for hours they're actually in the store.

Next--and this all depends on what industry you're in--you may need to speak with your lawyer to make sure what and how you're planning to compensate a particular position is legal. For instance, some jobs have minimum wage or other legal restrictions, such as waitstaff positions that are paid a low minimum wage but are assumed by the IRS to be generating income through tips. Unions may also have contracts that require particular wage levels or overtime pay.

Salary-based jobs are another matter. Salaries are fixed, so no matter how much work an employee does, they'll get the same amount in their paycheck each week. The original idea was probably to pay for contribution that couldn't be easily measured in hours. For example, an ad manager who creates advertising campaigns that bring in millions of revenue is paid a flat salary, since what she does is related to insight and results, not hours.

As time has advanced, however, paying via a flat salary has taken an unexpected twist. Hourly workers are paid more for working overtime. But there's no penalty to you (other than a moral one) to overworking an exempt salaried employee, so you can hire someone on salary and then demand 60-hour weeks at the salary of a traditional 40-hour-per-week job. Morale will tank, of course, and people will hate you, but if you can put up with that, it is an option.

Another way to pay is via commission. Some jobs contribute to revenue directly. For those positions, you can pay a commission based directly on the revenue generated. Salespeople are one type of employee who are often paid on commission. The logic is simple: We know what a salesperson is worth--the dollar value of their sales. So we can motivate them to sell as much as possible by basing their income on their sales volume. Most salespeople have a low, base salary and the upside potential of receiving a percentage of what they sell. Percentages vary, but I know one man who made a 5 percent commission selling a jet plane. Not bad work if you can get it.

Beware the trap of confusing commission percentages with the dollars you pay your salespeople, however. If you believe your commission percentage is right, let your salespeople take home as much money as they can. I've seen companies chase away phenomenal salespeople by getting greedy. They see a salesman taking home $1 million a year in commissions, they get jealous, and they cut commissions or fire the salesperson. Heck, if a salesperson is pulling in a cool million, let them! That means they're making tens of millions for your company. Don't cap their commissions and risk losing the salesperson who lays the golden eggs.

Lastly, you may want your salaried folks to have direct revenue incentives as well. The salary-equivalent of a commission is the time-honored bonus, which is a favorite perk for jobs that don't directly bring in the bucks. Bonuses are often tied to specific project results or to overall company performance: If the company does well, some part of profit gets held back and is distributed as a bonus.

The idea is that bonuses motivate people to work for the good of the company or the good of the project. That system works great--as long as people think they can really have an effect on the company. In practice, people's work is only vaguely related to the bottom line, so bonuses get mixed results as motivators. And if bonuses are steady, you also run the risk of people growing to expect them, so they become implied promises. Bonuses are handy, however, for rewarding people who do an exceptional job or as a way of providing a portion of compensation that can grow or shrink depending on the company's fortunes.

A Little Flexibility Never Hurt

Now that you know what you'll pay, what the market will expect and how you intend to tie pay to results, be prepared to get super-flexible if you're hiring executives and upper-level managers.

That's because, when it comes to the upper echelons of business staff, guidelines get fuzzy. Executives often get a mix of stock, salary and bonuses, set by a complex dance of greed, market rates and prevailing practice. Stock options claim to align executives and shareholders, but be careful! In a private company, this may work. But in public companies, options can encourage stock manipulation without long-term business results.

How much stock should you offer? That depends on how you value the stock and what you think it will be worth someday. There's not room to discuss it in detail here, but check out my site for a few ideas about dividing up equity.

If you're hiring an expert, meaning someone with a special skill, reputation or network, you'll also have to bend the rules, and everything becomes negotiable. Their expectations will be based on their past experiences and their awareness of market rates. If you really want them working for you, you'll have to be flexible. So craft a deal with short-term salary, long-term bonuses or stock, and performance-based targets as building blocks--you'll meet their needs yet leave them chomping at the bit in terms of motivation.

Finally, realize that you have a lot of flexibility if you expand your thinking beyond mere money. Some people value things other than money (yes, it's true!). You may be able to offer nonfinancial rewards that hook people and draw them in. Flexible hours, casual dress, more time off, telecommuting, and impressive or creative titles can all be offered in lieu of cash. Training and professional development also matter to people! So use the market rates, salary expectations, the intrinsic worth of the job, and your creativity when deciding what to pay. After all, having an on-site masseuse can count for a lot when you're working late!

Ready to review? Here's a quick summary to help you set salaries for all your staff:

• Set your upper salary limit by what a particular job is worth to you.
• Know the market to determine the least you'll pay.
• Match jobs whose value comes with hours to hourly pay.
• Match jobs whose value comes in insight or skill to salaried pay.
• Match jobs whose value is revenue to commissions.
• Use bonuses to align everyone around company or product or division goals.
• Customize the deal for experts and upper managers.
• Sometimes you can trade cash salary for intangibles or services.