As a VP Sales, one of the most important aspects of my job was to build effective commission plans and structures that incentivize the Sales team to deliver on our revenue targets. These conversations always started with a good ol' Excel Sheet and involved our CFO.
In this blog post, I will be discussing the various commission structures, including different types of guaranteed commissions that companies sometimes offer to their salespeople to smooth the transition with their new jobs.
A straight commission structure is one where salespeople earn a percentage of the revenue they bring in. They're more often than not and unexperienced Founder's wet dream. Sure, on paper, its sounds amazing: "I'll hire a bunch of people without salary and only pay them when they bring me money". In reality, it's almost impossible to attract the best talents without a base salary. Is your product that amazing, innovative and easy to sell that people would be willing to sacrifice their financial stability for it? I didn't think so.
This structure is commonly used in industries where the sales cycle is short, and salespeople are expected to close deals quickly. High turnover too. 0/10 would never recommend.
Salary plus Commission
The most common structure. The salesperson earns a base salary plus a commission on their sales. This is the most common structure as it typically involves a longer sales cycle and requires more relationship-building with prospects. The commissions can be calculated in various ways:
- Percentage of sales: This is the most common method, where the salesperson receives a percentage of the total sales revenue they generate.
- Gross margin: This method calculates the commission based on the profit margin of the sale. The salesperson receives a percentage of the gross profit generated by the sale.
- Tiered commission: This method rewards salespeople for achieving higher levels of sales. As the salesperson exceeds certain sales thresholds, their commission rate increases.
- Profit-based commission: This method ties the commission to the actual profit generated by the sale. The salesperson receives a percentage of the profit generated by the sale, after deducting expenses.
- Product-specific commission: This method provides a different commission rate for different products or services. The salesperson receives a higher commission rate for selling products that are more profitable or difficult to sell.
- Customer-specific commission: This method provides a different commission rate for different customers. The salesperson receives a higher commission rate for selling to customers that are more profitable or difficult to sell to.
Draw Against Commission
A draw against commission structure is where salespeople are given a guaranteed salary, but that salary is deducted from their commission earnings. The idea behind this structure is to provide some security for salespeople while still incentivizing them to sell. You can easily understand that a salesperson having a healthy pipeline and moving to another company will take a pay cut for the first few months (depending on the sales cycle) and will most likely need to build a new pipeline from scratch.
The draw amount is typically calculated based on the salesperson's expected earnings for a certain period, such as a month or a quarter. However, if the salesperson fails to generate enough commissions to cover the draw amount, the company may recover or "claw back" the excess amount from future commissions.
For example, let's say a salesperson receives a draw of $5,000 for the month, but only generates $4,000 in commissions. In this case, the company may claw back the $1,000 difference from the salesperson's commissions in future periods until the draw is fully repaid. Draw commissions with claw back are a way for companies to provide financial support to their sales team while also ensuring that the salesperson remains motivated to generate enough revenue to cover the draw amount.
Some companies offer guaranteed commissions to new salespeople to smooth their transition into a new job. This type of commission is usually offered for a set period, such as three or six months, and is intended to provide some security and stability for salespeople as they ramp up their sales performance. This structure can help salespeople feel more confident in their ability to sell and can reduce turnover during the early stages of employment. And yes, it's a major investment you're making on you sales folks. But if you consider this scenario, it's most likely because you realize that you're hiring an A-Player.
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