First place to look is your plans document

If you don’t have one, then there’s probably no legally binding obligation so you’re free to think about what you should do (not what you must do). If you do have a plan document (which you should), you will need to follow your own commitments. If the plan documents it includes a “management discretion clause” or beginning and ending effective dates (which it should), then you are under no obligation for future years (in most jurisdictions); however, your choices here will be watched carefully by current staff – so be sure your choices are consistent with the type of selling your people are doing. And that’s where we’ll focus for the rest of this discussion, on…

What type of sales role do you have

• Independent operators who build their own books of business with a high rate of renewal or repeat business
• New business sales people who sell multi-year deals into an assigned territory
• Account managers who manage and grow an assigned book of named accounts

There are many other sales roles, but these are the three for which the question of the future commission buy-out would be most likely to arise. (And if you’ve got another type you’re wondering about, please post a comment below or send me an email, and we’ll add it in if we’ve overlooked something!) We’ll take each of these one at a time.

Independent operators who build their own books of business with a high rate of renewal or repeat business

This would be typical of someone selling a subscription service (software as a service or business class internet services), or an ongoing agreement (insurance), investment management, etc. In these businesses, sales people work hard to land new accounts and make a modest amount of money in their first year, but make the more meaningful income as they grow their “book” based on the annuity stream it provides in the out-years. If the product or service being sold is available from other very similar competitors, then these sales people may be able to go to another competing company and have much of their book of business transfer with them. They are often on 100% commission plans (no base, or perhaps a modest recoverable draw against commissions).

These people are truly running their own business inside of their employer’s business. There are often arrangements at retirement for the successful sales person to “sell” their book of business to a younger sales person because that annuity stream has substantial value; and their employer may accept, or even encourage, this practice because it enhances the chance that those valuable customers will remain with them after the retirement of the long-time sales person. In these cases, there is often a buy-out in some sense, but it’s not the employer who buys out the future commission stream – it’s a fellow sales person.

New business sales people who sell multi-year deals into an assigned territory

This type of role is often found in large systems sales (software with implementation services, utility infrastructure, large scale construction). Deals are large, often with very long (multi-year) sales cycles. And the company recognizes revenue from these sales over a long period of time, typically several year. Sales people who lead the selling effort for these deals are often paid over the deployment period as revenue is recognized (sometimes with an up-front “win bonus” or other mechanics – but payment triggers is a whole separate topic). These sales people typically have a more substantial base pay, enough to live on (perhaps not comfortably) in the “building” years before the first deal is closed. Their compensation on the large deals may eventually make up 40% – 60% of their total compensation, but far short of all of it.

If a sales person who has been successful selling several of these large deals leaves the company before full payment is made, a few different approaches could make sense:

• Continue to pay the commissions under the standard compensation plans, even after the sales person has retired. This would be appropriate if the deals include substantial anticipated revenue that is not a full commitment (e.g., up to 1000 hours of professional services at $200/hour). In this case, the reason for the delayed payment may be that it’s not absolutely clear what the full value of the contract will be by the time it’s over – so the most sensible approach is to just pay it out as it would otherwise have been paid.
• Pay commission only up to the time of retirement. This would be especially sensible if there is an ongoing responsibility for managing the customer relationship through the deployment, and this responsibility will need to be assigned to another sales person when sales person retires. That newly assigned sales person will need to be paid for their contributions, so they would likely pick up the commission stream from that point. (Alternatively, there could be some sharing of the future commission stream if a good handoff is important to incentivize.)
• Buy out the future commission stream at retirement. If the full value of the deal is known at signing, and the comp value is also known, it may just be simpler for all concerned to calculate the expected value of the future commissions, perhaps discounting the out-years a bit based on the time value of money, and end the tracking and accounting with a check at retirement.

Account managers who manage and grow an assigned book of named accounts

These sales people are responsible for important accounts, often the largest and most important accounts in the company. They may have been the original seller, or they may have “inherited” the accounts from others who came before them. Either way, their job is to maintain and grow these account on behalf of the company. Typically they are coordinating multiple resources inside the company to serve the needs of their assigned customers. They generally have a substantial base pay, and a stated target incentive amount, perhaps in a 60/40 to 70/30 mix (%base / % incentive at target), with the ability to earn about twice the incentive target in a great year with great results.

These people are team players who are doing an important job inside the company as part of a larger group. Their incentive pay is really for this year’s results given the book and opportunities that came their way. No buyout of future commission payment would really make sense for them. In fact, their compensation plan is likely to be a bonus type plan and not a commission plan anyway.

By Beth Carroll and Donya Rose

The economy appears to have taken a positive turn and many companies are starting to think about growth:  hiring more sales reps, launching a new product, or breaking into a new market segment.  One of the first questions that is raised when a company returns to growth mode, especially if there has been significant retrenching, is, “What should we do with our sales compensation plans?” Odds are high that the right focus for the recession is not going to be the best focus for the company’s growth phase. It may be time to take a hard look at your sales incentive plans.  There are some key indicators you can check to determine if it’s time to make a change, and if it is, if you can afford to wait until January 1 (or the start of your next fiscal year) to implement the new plans.

1. You scaled back (or perhaps eliminated) incentive compensation during the recession, and now you see that your people are not engaged fully to capitalize on sales opportunities.You need to act as quickly as possible to regain momentum and re-energize your sales staff. While this is not a situation that should be left in place until the start of the next fiscal year, a full redesign of the plans may not be the only alternative. First, consider SPIFFs, contests and recognition programs. Are there things that can be done that will quickly drive new sales and create increased enthusiasm in a cost-effective manner? Second, consider adding a small “bounty” type incentive that provides additional income tied directly to the performance you need most right now (e.g., new customer acquisition), but that limits your exposure if sales opportunity radically exceeds or falls short of your expectations. Third, if you can, consider a stub-year plan that will shift people in the direction you will want to go at the start of the next fiscal year. If you filled in an incentive gap by increasing base salaries, you can start to move them back down again. If your employees have been earning 60% of what they earned in better years, you can start to bring that number back up again by developing a more modest incentive program with less leverage than was appropriate in more stable market conditions. In addition, you should consider the culture that has been enforced (or created) by your sales compensation program. Should you add a team-based element to keep the focus on working togethe
2. You scaled back your expectations in terms of goals or volume production, and now you are starting to see payouts that are far higher than you expected. This is also a situation that has the potential for serious negative consequences on two fronts. First, your company’s financial performance could be adversely affected by overpayment in the incentive program. Second, your employees’ sense of their own value in the market place could be inflated beyond reasonable expectations. It is remarkable how quickly salespeople come to expect a higher level of earnings on an on-going basis once they have experienced it for a few months or quarters. It can be very hard for them to accept the adjustment that will inevitably be required. Quick action is needed to recalibrate expectations, supported by thorough modeling to make sure that pay levels return to appropriate levels without damage to morale, and while still providing significant upside earnings potential for true top performance.
3. You are finding it difficult to hire top talent, and the reason cited is the lack of a competitive compensation package. You can take a two-pronged approach on this and develop a plan for new hires that would be a lead-in to next year’s plan for the existing staff. Because many companies provide a guarantee for new hires, such an arrangement is possible for a few months before any significant discrepancies in the two versions of the incentive plan are felt. However, you will want to make the transition strategy clear for the incumbents so they know that at a specific future date they will be moved onto the new incentive plan as well. Many salespeople have become leery of 100% variable plans, as they’ve seen what can happen when they fail to cover their draw month after month. Even top salespeople in industries that are highly risk-tolerant may be more interested in finding programs with at least a modest base salary. A 40/60 to 60/40 pay mix is reasonably aggressive, and yet either option allows some degree of control from an employer/employee perspective while providing salespeople with a greater sense of security. Of course, the less variability in the plan, the less leverage on the upside, as this is a necessary trade-off. But it is one that can be designed to provide very attractive earnings opportunities to true top performers.

Question

Our sales people sell long-term deals, most of which span several years. When should they be paid for these – upon signing, as invoiced, when revenue is recognized, at completion, or a combination of these?

Answer

We have seen several different compensation arrangements for long-term deals, which are often found in subscription businesses (e.g., SaaS, phone/internet service, online test delivery), and complex multi-year implementations requiring installation/configuration (e.g., enterprise software, utility infrastructure). Some businesses pay the sales people who sell these long-term deals all at once, and others stage the payment over time. The most common arrangements we have seen are listed below, along with some idea of when they are most valuable:

Pay upon contract execution

This is most common when the sales person is a pure “hunter” and there are project management or account management people in place to take the hand off after the contract is signed. The sales person has “done their job” when the contract is signed. And the value of the contract to the company is very likely to be exactly as expected at the time of signing.

Pay as invoiced

In this case, the customer may pay a portion of the agreed price at signing, then pay over the course of the contract, perhaps as milestones are attained, or perhaps on a regularly monthly schedule. Often the sales person will receive payment after each invoice is created. In many types of business this will also align with revenue recognition (when goods are shipped), but may not (especially in the case of software sales or professional services for installation). This type of payment policy will keep the sales person focused on ensuring the contract is executed as planned, and invoices are generated. It will also allow the company to better align the cost of the sales compensation with the income received. And in cases in which the contract is for a rate (e.g., for bandwidth used, hours of professional services, or tests delivered), it will ensure that the sales people is paid fairly for actual realized sales.

Pay when cash is received

If collection is often an issue, or if sales compensation cost must be funded directly out of cash receipts, a cash-based payment policy may be used. This will have the effect of focusing the sales person on seeing the transaction all the way through to collection. This is most commonly used in cash-flow-constrained early-stage businesses. Most more mature businesses find that well-written contracts and careful negotiation of terms, combined with customer-pleasing delivery and a capable accounts receivable function ensure the cash comes in; and they would rather have their sales people focused on selling than on collections.

Pay when revenue is recognized

Especially in the sales of licensed software, software as a service, and professional services associated with software implementations, revenue recognition rules come into play. It is possible for contract to be signed, and even for substantial cash to be received, and yet for the company to not be able to recognize significant revenue until a later quarter or year. When revenue recognition that is potentially out of alignment with order acceptance, invoice generation, and cash receipt is an important business goal, sales people may be paid based on recognized revenue.

Pay portions of the compensation on a deal based on a combination of the above “triggers”

In some cases, several of the objectives cited above may be in play. For example, there are new business “hunter” sales roles for which the “handoff” to the project management team happens over a six month period while implementation is under way. In such a case, 50% 0f the payment for the deal may be made following contract signing, and 50% following completion of implementation.

Key principles

1. Finish paying the sales person at the point at which you would like them to disengage and focus on the next deal for the typical deal.
2. It’s reasonable and appropriate to include charge-back provisions so that sales credit and payment will be reversed if deals fail to materialize as anticipated. This should only be used as a fail-safe when such reversals are rare (well under10% of deals).
3. The payout arrangement has to work for the sales person and the company – so if the company is cash-strapped, payment aligned with cash collection may need to be considered.
4. Beware annuity “tails” – they create plan administration complexity, encumber the company years from now based on a plan designed today, and, over time, may create a situation in which current year pay is not tied to current year success for sales people.

Question

We sell long term, high volume contracts. Should our sales people be compensated through the entire term of the contract, or should they receive an initial commission which diminishes over the term of the contract?

Answer

The applicable principle here has to do with the definition of the sales job for those long-term contracts. If the sales person is expected to “account-manage” the account and ensure satisfaction throughout delivery (perhaps while also looking for opportunities to expand the business in the account), then payment over the life of the contract would be appropriate. If, however, the sales person hands off the signed contract to a delivery team and is expected to then begin to focus on the next opportunity, then completing payout closer to contract execution would be in order. And in between these two would be the situation in which the sales person’s role is expected to diminish over time, in which case a commission rate which decreases each year over the life of the contract would be appropriate.

The rule of thumb is that you finish paying the sales person for the deal at the point at which you would typically expect them to disengage and move on. That said, the company may also reserve the right to reverse sales credit if the contract is cancelled, or if the eventual contract value is materially less than the value at signing.

One major exception to all this is in the case of contracts for rates as opposed to fixed price contracts. If the contract is for a rate and the total volume is not known or committed to at the time of signing, it may be necessary to pay out as the business is invoiced over time.

A significant disadvantage to paying out over time on long-term contracts is that it will tend to create a long annuity “tail” of payments which can serve to make sales people far more focused on managing those existing already-sold deals than on landing new ones. While some will argue that the annuity tail serves as a retention tool, consider who you are retaining with it. Those who expect to sell significant deals in the future would prefer the more substantial up-front payment and a “tail-less” plan. Those who prefer the plan with a tail would be those who prefer to create a comfortable cushion to mitigate their future risk.

Question

What do we do when a sales person leaves the company before the last payment is made for a contract closed by the sales person? Do we still pay after termination?

Answer

There are three reasons most often cited for paying over several years on a multi-year deal:

1. The value of the deal is not really clear at contract signing. This would be the case if the contract were really for a rate vs. for a guaranteed total price paid at pre-specified dates. For example, one client in the business of delivering online testing contracts for a rate per test, but the total test volume can be very hard to predict. In such cases, even if the sales person is really mostly responsible for closing the deal, and someone else picks up the delivery/client management, the payment needs to be made after revenue is recognized.
2. The sales person needs to stay involved to keep the customer happy and make sure the contract “goes.” This is the case in a combination sales/client management role where the deal could end up not being as-signed if delivery is not managed carefully, and the organization wants the sales person involved in ensuring things go as planned (or another way of saying this that things go as that sales person promised they would).
3. The company believes the promise of future payments is a good tool for retaining top sales talent. (You’ll find that we question this assumption, but that’s the topic of a future post.)

In case of #1 above, you might consider continuing payment as the rationale for not paying up-front is that you don’t know how much to pay. However in cases #2 and #3, you probably would prefer to avoid paying the terminated employee. Depending on the nature of your sale and your compensation plan, and local (state) laws, you may have no choice but to pay the terminated employee. However, for many sales roles a helpful approach is to include language in your sales compensation plan document (you do have one, and it’s signed by your sales people and their managers, and a record of this is kept by the company, right?)… anyway, include language in that plan document that says that that…

The commission is earned when the final payment on the contract is made, that the sales person must be employed at the time the commission is earned to be eligible for payment, and that all payments in advance of that event are advances against those future earnings.

So, for example, if your sales person sells a 3 year deal with annual payments, and if your compensation plan pays annually when payments are received from the customer*, and if the sales person leaves the company after receiving the 2nd of those three expected payments, then technically you would be owed the first two payments. However, you should probably make it standard practice to “forgive” that “debt.” But it would be quite clear that you do not owe the third payment.

We are not attorneys and cannot give legal advice, but have recommended this approach to many of our clients, and their attorneys have felt it was a good idea and legally defensible.

*Note that annuity tails in compensation plans like the one described in this example have their own issues, and we do not generally recommend them. Check back for a future post on the topic of compensation for multi-year contracts.

Question

My company is in the throes of revising the comp plan for next year and one of the most hotly debated items revolves around compensating a salesperson on all business generated from dollar one for the life of the account. Currently our firm doesn’t discriminate between “new” dollars and what I’m calling “annuity” dollars- they pay the same rate over the account life whether it’s 1 year or 10. We don’t have a lot of support staff so most, if not all the account maintenance falls on the salesperson’s shoulders. Most of the heavy lifting is done during the prospecting stage & within the first 1-2 years of the relationship then the historical pattern is the revenue drops (variety of reasons outside of the salespersons control and some within).

Answer

There are several ways to put together plan mechanics in such a situation, and I have listed a few below, with some commentary.

1. First dollar payment, and “a dollar is a dollar.” This is what I believe you have now. This will focus sales people with substantial annuity business first on maintaining the base, then once that is secure, on growing new business. It generally is straightforward to track sales credit and calculate compensation – both very desirable. The cost of comp in relation to sales volume is very predictable, as is the income level of the sales person. The challenges raised by this arrangement are:

1. a. It does not recognize the increased degree of difficulty in landing truly new business – so that the time spent on new business development may not be worth the risk of not closing to a sales person who can farm established accounts.

1. b. It can result in a “phantom base” where the sales person has a large portion of their apparently variable pay that will almost certainly not vary year to year – so they have little real risk or upside in their compensation plan to help support the drive to grow.

1. c. Depending on how the compensation plans work, it may mean that each deal is paid over the life of the contract based on the comp plan in place at the time it was signed. If this is the case, the compensation administrator may be simultaneously administering several comp plans (this year’s, last year’s, etc.). This would tend to limit the company’s willingness to adjust the plans to focus sales effort on this year’s priorities.

1. d. Sales people with “rights” to an annuity stream are less likely to accept restructuring of territories to expand the sales force, reassignment of accounts, etc. This can limit a growing company’s ability to scale quickly and maximize market penetration.

2. Added payout value for new business. This is similar to #1, except that the payout on the “existing” business (“existing” vs. “new” needs careful definition) is reduced to fund a higher payout amount on the “new.” Generally the intention will be to keep total compensation the same, but to shift the emphasis to the new business a bit. This can be as simple as an increased commission rate for all new business during its first twelve months, funded by a reduction in the commission rate for existing business. This solves a above, b somewhat, and does very little to address c and d.

3. Split the compensation into a quota-based incentive for the existing business and a true commission on the new business. For the quota-based incentive on existing business, there may be a threshold below which no payout is earned (e.g., 80% of the quota), and dramatic acceleration for any over-quota attainment (e.g., double the target incentive at 120% of quota). For the new business, the payout should be from first dollar and perhaps it should accelerate over quota. In this case, business should count as “new” for the first twelve months, not just for the rest of the plan year. This approach solves issues a, b, c and d listed above; but it also undermines simplicity, makes it hard to know the comp value of existing business on a per-deal basis, and raises the stakes on setting reasonable and accurate quotas for both existing and new business.

There is not a perfect answer to this situation that will satisfy all stakeholders and be bullet-proof. But there are better and worse approaches, depending on your sales roles and your business model.

Question

In professional services, do you compensate differently in sales plans for “new” business vs. maintaining an account to incent the best “prospectors” to develop new business?

Answer

I’d say that the best course would depend on both the company strategy and the way the selling roles are defined. If the strategy is focused on penetration of existing accounts, then the most valuable sales might be those in current accounts (this tends to be true with mature companies who have some kind of relationship already with most of their key prospects).

But for the majority of our clients, new business is very important. You’ll have to be clear about what counts as “new” – a new “logo” (new company name…), a new buying entity (maybe a new division/location in an established customer could be counted as new), a new service offering (generally one that does not replace an older legacy service they have been buying). Generally “new” business (however you define it) takes more time and effort to win than renewal or penetration business, and for that reason you’ll need to reward for it at a higher level in order to keep sales people focused on it.

Another approach successfully employed by companies with enough sales people to do this is to separate “Account Management” from “New Business Sales” so that different people/teams are responsible for those different selling activities. This may not be practical in a small sales force – but once a company achieves enough scale to operate this way it allows the focus of those who love the new business hunt to be where they do their best work, and those who love the longer-term relationships and more nurturing selling role can focus on managing and growing existing accounts. If you do end up splitting the role into Account Managers and New Business Hunters (sometimes called Sale Executives), you will probably want to have different pay plans for those two roles (e.g., quota bonus with a threshold and significant acceleration for over-quota performance for Account Managers; first dollar commission with lower quotas and less acceleration for New Business Sales).

Question

I need benchmark data on what percentage of annual gross revenue should come from new business and should be allocated to sales force compensation. For example, if in insurance or other annuities there is a commission on first year premiums only and not on renewal business or a reduced rate on renewals. I assume that the 1st year budget for acquisition is higher than maintaining existing customers, but I am curious is that is really the case or if there are any good benchmarks to use as a reference.

Answer

I believe your question is about sales roles with a new business focus when the acquired business generally turns into a long-term annuity type relationship. Examples from my experience include insurance policies, ASP software offerings, software leasing, online test delivery contracts, EDI services, data and voice communication subscriptions. In all these cases, the company most values the acquisition of new business, and counts on the quality of the service delivered to retain it.

In these business models, new business sold earlier in the year contributes more to in-year revenue than that sold later in the year as the revenue is generally recognized monthly. For this reason, much of the incentive design effort may be aimed at rewarding those who acquire significant new business early in the year by measuring “in-year new revenue.” Retention is sometimes the job of the new business sales person, but is often assigned to a different Account Manager or Client Services role. If the same person is doing both new business and account management, the total revenue from new business may be very small compared to the total revenue from the existing assigned book (5% – 20% of the total). Often the new business is commissioned (based on new in-year revenue or total contract value), and the retained business is handled more as a quota bonus, with the weight on each component proportional to the expected time allocation.

But to get to your specific question, the budgeted sales comp % revenue is likely all over the place, depending on industry and company stage of growth. In very high margin businesses (software, data services), you are likely to see a higher comp % revenue. Similarly, large deal sellers (deals in the millions, tens of millions and more) would see a smaller percent of revenue as their comp; and small deal sellers (I’ve seen deal sizes in the thousands of dollars) would earn a larger percent of revenue. And in earlier stage companies you are also likely to see higher comp % revenue. The right comp % revenue is really based on the market value of the job (numerator) and the selling model, which generates a reasonable sales productivity expectation per person (denominator).