Great sales compensation plans and commission structures need to accomplish quite a lot. A good compensation plan and sales commission structure needs to provide fair compensation to employees in customer-facing roles.
It needs to incentivize specific behaviors and actions that suit the needs of both the company and the customer.
And of course, a strong sales compensation plan with generous sales commissions needs to motivate reps to hit goals that grow the company while still maintaining a profit margin.
What is a Sales Compensation Plan?
A sales compensation plan lays out how you are going to pay different salespeople for their contribution to the business. Typically it will include two main elements: base pay, and variable pay, sometimes known as incentive pay, or commission.
Somes sales compensation plans include only commission, while others include only base pay. Most include a mix of the two.
How to Create a Sales Compensation Plan For New Reps
Whether you’re building a sales compensation plan from scratch or rebuilding an old one, you should take the following steps in order:
- Understand the Basic Requirements of a Good Sales Comp Plan
- Establish Role Levels
- Determine Total On-Target Earnings (OTE)
- Decide Base Pay and Sales Commission Structure
- Set Targets
- Plan Compensation for Onboarding and Training
- Know what to Include in a Sales Incentive Plan
- Create a Contract and Get Mutual Commitment [TEMPLATE PROVIDED]
Step 1: Understand the Basic Requirements of Good Sales Compensation Plans
A good sales compensation plan is a win-win-win: It’s easy to implement and benefits everyone. Here are 5 things to keep in mind when planning yours.
Keep it Simple. A summary of your compensation plan must fit on a single page.
Show Causality. Make compensation directly related to the desired effect you wish to achieve.
Think Short. Keep the time between activity and compensation under 60 days.
Be Fair for Everyone. All compensation must be fair and equal to everyone.
Make it Easy. It should be easy to measure, easy to administer.
Step 2: Establish Role Levels
Establishing your role levels can become a complicated process. To avoid getting bogged down, create just three levels, based on experience levels:
- Experienced/Top Performer
Here’s a simple example to begin with that covers the SDR, AE, and Customer Success Manager (CSM) functions:
Table 1. An overview of three titles
With these three role levels, you can easily define the differences between un-tested, new employees and those with experience. It also puts you in a position of offering “micro promotions,” which can help motivate people, especially early in their careers.
Step 3: Determine Total On-Target Earnings (OTE)
Before you can decide base pay or commission-based pay, you need to decide On-Target Earnings or OTE.
On-Target Earnings (OTE): what the person would be paid annually. It includes two elements: a base salary and an incentive packaged based on sales, also known as commission, or variable pay.
Be aware, OTE will vary depending on your geography (and possibly your industry).
Here’s an example of OTE levels for a SaaS business hiring sales talent in the Bay Area:
Table 2. An overview of sales compensation by role in the Bay Area
NOTE: We recommend that you avoid calling any sales commission a “bonus.” A bonus is not guaranteed and is usually given on the spot.
A compensation plan (or incentive plan) is just that: a plan. It ties payment to the achievement of specific objectives that have been:
- shared on the incentive plan
- clearly communicated to the employees
Step 4: Decide Base Pay and Sales Commission Structure
The goal of variable pay is to develop a performance-driven culture in which your sales team is financially accountable for results.
The ratio between base pay and sales commission is sometimes called “leverage.”
A plan with a high variable and a low base salary is referred to as a highly leveraged comp plan. To some leaders, highly leveraged plans sound great, because you only pay for results.
This can create a lot of issues.
For example, senior sales talent and top performers may not be interested because the banking system penalizes those who rely heavily on sales commissions when they apply for a mortgage, car loan, or any other form of credit.
Highly leveraged sales compensation plans are mostly seen in transactional sales, where the volume is extremely high at low prices.
Let’s look at a few examples. Here are some highly leveraged and low-leverage compensation plans, and the situations where they might apply:
Table 3. An overview of leverages commonly used
OTE and the breakout between base pay and sales commission can change depending on your location. I usually recommend my clients consult with a local recruiter if they’re unsure of the expectations of the job market.
Here are a few other variables that can affect pay:
Table 4. Variables impacting sales compensation plans
Just to paint a picture for you, look at the range of salaries for an AE as of Mid 2020:
- Atlanta-based AE. Base/Sales Commission: $80,000 / $80,000 / OTE $160,000
- Denver-based AE. Base/Sales Commission: $75,000 / $75,000 / OTE $150,000
- NY/SF-based AE. Base/Sales Commission: $100,000 / $100,000 / OTE $200,000
Obviously, the balance between base and commission-based pay varies by role as well.
Step 5: Set Targets
How you set targets depends on your specific business model. You need to consider a wide range of factors, including:
- your financials
- whether you receive recurring revenue
- how you charge for services
Since many SaaS businesses have similar financial models, I’ll use that as an example.
There are three models of target setting for a platform product with an average contract value (ACV) of $25k:
1) Top-Down Target Setting
Take the Annual Recurring Revenue (ARR) you wish to achieve, and divide this by the number of salespeople.
So let’s say you want $4M in ARR and have 4 salespeople.
$4M / 4 = $1M ARR/salesperson.
You then divide by the Annual Contract Value (ACV) per deal.
So, assuming an ACV of $25K…
$1M ARR/salesperson / $25K = 40 deals won per year
40 deals / 12 months = ~3 deals per month
The problem with this older B2B approach is that it lacks predictability, and it is hard to measure where things go wrong.
2) Bottom-Up Target Setting
Take “till date” numbers and use 80% of the best month ever as your guideline.
For example, if your Founder closed $800K in business in the past 12 months, at an ACV of $25K, the target for a new salesperson would be $640K.
$800K x .80 = $640K per salesperson
$640K / $25K ACV = ~25 deals per year
To hit the $4M revenue goal, we need about 6 salespeople.
$4M / $640K per salesperson = ~6 salespeople
The problem with this model is that a founder-based sales system is not scalable. Founders can do things sales reps can’t.
This is a common situation with today’s sales organization since the costs of acquiring a client have shot up radically.
3) Business-Case Target Setting (Recommended)
The sales acquisition team sells a CRM platform using one SDR ($80K), one Jr. AE ($160K) and ½ a CSM ($120K/2) to prospect/win and onboard 20 deals/month at $25K ACV.
That level of growth costs a total of $300K each year. To profit on that growth, the team needs to bring in at least $300K, but we actually recommend 2x that number = $600K.
Why? It takes 3 months to ramp the team:
- Year 1 $600K / $25K = 24 deals (take into account a 3-month ramp)
- Year 2 $900K / $30K = 30 deals
For a SaaS model, here’s an example of how targets can be set across roles:
Table 5. An overview of sales targets by role
NOTE: Lifetime Value (LTV) has an enormous impact.
Lifetime value (LTV) is how long someone keeps using your product, on average, once they’ve bought it.
For example, within the FedTech space, sales contracts can be established with 3 years of commitment. This allows for richer sales compensation plans than at companies in AdTech, where LTV is only nine months, on average..
With new products, where LTV is not yet established, we advise that you spend less than 40% of year-one revenues on the total OTE of your SDR, AE, and CSM.
For the same reason, we recommend that businesses with LTVs of 2+ years spend less than 60% of year-one revenues.
When should you pay sales commission?
Should you pay commission on booking or cash collection?
This is a touchy subject because a booked client does not guarantee cash collection.
If you want to use this method, here are some baseline thoughts to think through:
Compensation against bookings accelerates deals and is used during growth. On the other hand, compensation on cash collections improves the quality of deals and is commonly used during maturity.
Early-stage companies do not like handing out commissions before the money is collected, but compensating on cash payments doesn’t help.
Here are several of the main problems with sales commission structures based on cash payments:
- The delayed incentive makes it hard to determine how the incentive plan affects performance because it’s hard to establish causality.
- Cash payments make it harder to motivate a team because their reward is often delayed up to 45 days after the deal closed
- It causes higher churn and is a signal to top sales talent to avoid your company — they assume “something must be wrong if they can’t pay their salespeople on time.”
Besides, there are easier ways to ensure that commissions are only paid when a customer pays:
- Clawback the next month. Any deals that fall through after signature can come out of next month’s commissions check.
- Or, you can simply adjust quota upwards to account for an expected level of premature churn.
Step 6: Plan Compensation for Onboarding and Training
Any professional earning $10,000 a month in sales commissions will have trouble agreeing to forego that income for 3 months by coming to work for you.
So it’s quite normal for new reps to ask for compensation above their base pay during onboarding. There are several ways to structure sales compensation plans during ramp.
Imagine you hire an AE who you expect to pay $10K in commissions each month after they’re ramped up. Let’s look at some examples of how you may compensate that person in the first few months of employment.
A guaranteed payment which gets subtracted if the rep hits their commission targets.
For example, you pay the sales rep $6.67K per month. If they close $10,000 worth of commission, you pay the remaining $3,333 extra. If they close only $5,000 of commission, they keep the remaining $1,667.
Any sales executive in a start-up will request a non-recoverable draw as part of their sales compensation plan.
Effectively a loan against commission over a number of months.
For example, you pay $6,667 per month upfront. If they only close $5,000 worth of commission, $1,667 rolls over to next month. If they hit $10,000 the next month, that $1,667 is deducted before payment.
A recoverable draw makes more sense if your sales rep is taking over an established territory where brand name helps close 80% of the business.
What’s the difference between a recoverable draw and a clawback?
Just to clear up any confusion, let’s look at how a recoverable draw differs from a clawback.
Unlike a recoverable draw, a clawback requires the salesperson to pay the company back immediately if they don’t hit commission. So the employee gets the money upfront but would have to immediately hand back $1,667 if they only made sales worth $5,000 of commission.
Clawbacks can also be used against deals that churn within three months of purchase when the commission was already paid. Deals like this are the result of selling to the wrong customer. Any clients that churn after the 3-month mark are considered the responsibility of the Customer Success team.
Example of a Draw
Here’s a table that illustrates how a draw might work for an AE onboarding over the course of 4 months. The 4th line shows what you’d payout if you’ve opted for a non-recoverable draw. The 5th line shows what you’d payout if you’ve agreed a recoverable draw.
Table 6. Impact of recoverable vs. non-recoverable draw
This particular example is linear and is based on a compensation plan of 10% of sales, with a target of $900K. That would mean on target commissions would be $90K per year or about $7.5K per month. We’ve also assumed that there’s a 90-day ramp.
Earning the Draw
Here are a few ideas to motivate your new employee to earn the non-recoverable draw:
Table 7. 90 Day Onboarding Program
Step 7: Know What to Include in a Sales Incentive Plan
Your incentive plan should include several key sections that clearly spell out your sales commission structure.
Monthly vs. Quarterly Commission Payments
The evidence is clear: monthly payments reduce the hockey-stick effect (when a disproportionate amount of revenue closes at the end of the quarter). There are very few exceptions to this.
With often 50% of the compensation locked up in commissions, you must pay compensation on time, with the same due diligence as any other salary compensation.
The norm is 1 payment cycle after the quarter closes, e.g., within 30 days of month close.
This protects the upside. For example, “capped at $400,000 annually” means that if total comp exceeds $400,000, the person will not get paid above $400,000.
This is common practice at companies working strategic deals with large teams. For example, a Fortune 500 company may choose to deploy an enterprise-wide solution following a series of meetings between the CEO and VPs — but not AEs. The AE should be notified that Capping may apply.
Sales compensation plans should have an override by the CxO/VP to overcome unknown scenarios.
For example, one year my team fell $400K short on quota. My CEO worked with a board member to have another portfolio company “buy” our solution to overcome the shortfall. This is a situation I experienced where the override was enforced.
For good reason, sales compensation receives a high level of scrutiny. The aim? To be equal, regardless of gender, age, race, etc.
But in practice, performance typically beats equality, which can be a problem.
For instance, it’s common practice for a VP of sales to bring in a former sales performer or individual contributor at an increased pay rate, since they are a known entity.
When that happens, it can create unfair compensation. It can also lead to another performer being let go to make room for this superstar. Either way, it can be grounds for a lawsuit.
Another example has to do with underperformers. If you choose to let them go, be aware: If the contributor was not fairly compensated during their tenure, there is ground for a lawsuit even if the contributor underperformed.
Fair Compensation Board
Winning By Design strongly recommends portfolio companies with more than 25 people to establish a Fair Compensation Board. In it, the CEO, an internal executive, an industry expert (often a board member), and an external HR professional agree to review compensation and ensure fairness on a quarterly basis.
Using a fair compensation board prevents you from hiring people with insane compensation packages. It also allows you to take note of underrated performers, who can be put on an accelerated career path.
Step 8: Create a Contract and Get Mutual Commitment [Template]
If you’re looking for a sales compensation plan template, look no further.
Here is an example language you can use to create a documented version of your now complete sales compensation plan.
Appendix A – Sales Compensation Plan Example
Revision Date: April 23, 2019
This document describes the agreement between ______________ (“Company”) and ______________ (“Payee”) regarding terms related to sales incentive compensation. Company and Payee enter into this agreement whereby Payee provides services to the Company in return for compensation specified in this agreement.
All commissions will be calculated and paid once every month, for the preceding month. Commissions will be calculated and paid out as part of the next payroll cycle, following the month for which commissions are calculated.
Base Salary Payout – Sales Rep is due a base salary of __________ , payable every __________.
Sales Incentive Payout – Sales incentive compensation is payable every __________.
Expenses – The Account Executive will be paid for all travel and lodging expenses related to sales activities within 30 days of being presented with the receipts and a completed and accepted expense reimbursement form.
Travel and Lodging
- Auto travel: Reimbursed at the current federal reimbursement rate
- Cell phone: Sales Reps will be required to maintain a cell phone as part of conducting sales business. Sales Rep will be provided an allowance of $50 per month for cell phone usage.
Client entertainment expenses will be reimbursed as following:
- Meals/Coffee: Reimbursable with receipts
- Special Events: Must be pre-approved. Reimbursable with receipts
Draw –Payee receives a monthly un-recoverable draw against the sales incentive plan as follows based on the participation and completion of the 90 Day Onboarding Program.
Table 2. Eligible Draw Month-over-Month
- Clawback – In order to receive your full commission with no clawback, the customer must stay live for 3-months from the day we start billing the customer. If a customer cancels short of the 3-month mark you will have a prorated amount clawed back from your commission against the sales made.
- Draw Clawback – If payee voluntarily leaves the position within the first 6 months of this plan, the Draw payment(s) will be due back to the Company through a payroll deduction from any monies owed to Payee.
- Splits – Commissions can be split with other Payees, on a deal-by-deal basis at the discretion of the VP of Sales.
- Termination of Employment – On voluntary or involuntary termination of Payee employment with the Company, commissions will be paid on transactions dated prior to the termination date only. Any amounts owed to the Payee will be according to employment regulations after withholding taxes and other dues.
- 90 Day Onboarding Program – The onboarding program will take place over 90 days and the following activities are expected from the Payee to be eligible for the Draw as outlined in Table 2.
Other Important Terms
- Payee agrees to follow all Federal and Local laws while engaged in providing services to the Company during the period of this agreement.
- Payee shall not engage in any other employment during the term of this agreement. Company reserves the right to require Sales Rep to terminate any such other employment at Company’s sole discretion.
- Payee shall use the most ethical practices while engaging in any sales activity.
- Payee agrees to protect all confidential material including prospect data, sales data, and client information belonging to the Company and shall take all reasonable care in making sure that such confidential material is not disbursed to anyone outside the company.
- This entire agreement shall be governed by the laws of the State of _______________.
- VP of Sales reserves the right to override the terms of this agreement without cause.
Sales Compensation Plan Examples and Commission Structure Templates
Once you understand how to create a fair compensation plan for your sales team, you can check out some examples:
This is how the sales compensation plan should work for reps in a prospecting role. This could be anywhere from a first SDR job focused on inbound, to a senior SDR calling on key accounts with 1–4 years of experience.
This is how the comp plan should look for those in closing roles. This plan can cover anybody from a first AE job to 3–5+ years of experience (AE) or 4–8 years of experience (Sr. AE).
SDR Sales Compensation Plan Example
- Business model: $900,000 in ARR, across 30 deals with an ACV of $30,000
- SDR compensation: $40,000/$40,000 fully ramped
- Win ratio: 1 in 5 (this is the norm in SaaS sales vs. 1 in 3 in perpetual sales)
- Lifecycle: Fully ramped
Model: $40,000 in variable comp needs to bring in enough deals to win 30 deals per year
- Linear model: 30 deals per year, with a 1:5 win rate equated to 150 leads per year. $40,000/150 = $267/SQL. Or rather $250/SQL. As the SDR generates 12 SQLs/mo = $3,000 in commission. This also means that for every deal won at an ACV of ~$30,000 with a 1 in 5 win ratio you thus will have to pay for 5 SQLs = $1,250.
NOTE: In comparison, it is common to pay $500 for a meeting and $1,000 for a meeting with a decision-maker generated by an external firm. Also a referral fee of 5% ($1,500) is common for an intro at manager/VP level and 10% ($3,000) at CxO/Board level.
- Accelerated model: This is used to drive behavior to qualify the right deals.
- We look to spend $1,250 for 5 SQLs since this is what the business model is
- We then pay less per SQL – say $150
- So we pay total for 5 SQLs @ $150 = $750
- Leaving us $500 – so we now pay out $500 for every deal close
- You end up paying the exact same amount but drive behavior to identify quality SQLs.
- Business model:
- Drive opening a new market: $150 for Medical company, $250 for Financial Institution
- Drive to get seniority: $100 for a meeting with the manager, $150 for a meeting with a CxO/VP title
IMPORTANT: The definition of an SQL and a SAL needs to be clearly defined either in the comp plan or hung on a poster on the wall where it is clearly visible for all team members. We encourage you, not only to give examples of what an SQL is, but also to give examples of what does NOT constitute an SQL.
Table 8. Example Comp Plan for a Sales Development Rep
- Split model:
- The SDR function has been under pressure as their comp plans have been held accountable against market metrics that frequently reset themselves. Whereas a few years ago generating 30-40 SQLs/SDR/month was quite feasible, today we are looking at 10-15 SQLs/SDR/month. This fluctuates between markets, regions, etc. Due to the lower SQLs count, you may find yourself following the model and concluding you need to compensate the SDR $500 or even $1,000 per SQL. Such as high $ value per SQL invites an SDR to game the system. We recommend that in such cases, you split the model to a point where you reduce the price per SQL to about $200-250 (along accelerated model), and add compensation for productivity performed in the form of number of emails, calls, event sign-ups, visits at a tradeshow booth, etc.
Table 10. Metrics to keep in mind
- Quality vs. Quantity
To generate a volume you can compensate on Sales Qualified Leads for a Meeting, set (SQL). This may flow a high amount of unqualified deals in. To create a level of performance that AE can accept, set the Sales Accepted Lead (SAL). This offers you three options to guarantee quality.
- Compensate on SQLs and lower the price per SQL from $100 per SQL to $50. Note that you are wasting AE resources, as they have a lot of unqualified calls.
- Compensate on SALs instead of SQLs. This reduces the velocity and creates a strenuous relationship between the SDR and AE, as the AE disqualifies deals that SDR worked hard on.
- Add a Quality Measure by shifting the gravity of the compensation to a comp plan, $50/SQL + $500/deal won.
- Clawback at the end of the month — take out all deals that did not turn into an opportunity.
Account Executive Sales Compensation Plan Example
- Model: Business-case target setting
- Revenue: $900,000 / 30 deals
- Average contract: $30,000
- Compensation: Jr. AE. $80,000 base + $80,000 variable
- Lifecycle: Fully ramped
Model: $80,000 in variable comp needs to bring in $900,000 across ~30 deals with an ACV of $30,000.
- Linear model: $900,000 in 30 deals vs. $80,000 in compensation = 8.8% of every sale every month, good for business at the speed of 2-3 deals per month using a 2-stage (SDR/AE) based sales organization.
- Accelerated model: Drives behavior to close more towards an end of the season.*
- 6.4% on first $500,000 ($32,000 in commission)
- 12% on $500,000 – 900,000 ($48,000 in commission)
- 15% over $900,000 (upside)
*Requires matching of the commission season to the buying behavior you want. For example, schools/districts buy in March to July, Federal government from August to October, Enterprise Nov to Dec, Retail March to July.
- Business model:
- Size of deal: Very effective to drive a team to sell more items to increase the price:
- 5% on deals < $20,000k, 10% >$20,000, 15% on deals over $30,000
- Market: Very effective to open up new markets:
- 7% to schools in CA and 10% to schools in Colorado
- Product: Very effective to drive sales of new products:
- 5% on standard platform, 8% on add-on services X, and 15% on a new platform services
Table 11. Example Comp Plan for an Account Executive
Table 12. Example Payout of the Account Executive, Accelerated Model + Business Model
This is part of the Winning By Design Blueprint Series in which we analyze and provide practical advice for every part of a SaaS sales organization.