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How to Build an Effective SaaS Sales Compensation Model For All Customer Facing Roles
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. In this Blueprint we explain how to build a sales compensation plan for the following customer facing roles:
Sales Development Rep (SDR); Prospecting – Anywhere from a first SDR job (Jr.) focused on inbound, to a senior SDR job calling on key accounts (Account Development Rep) with 1-4 years of experience.
Account Executive (AE); Sales Acquisition. Sometimes also known as Sales Manager (SM). Anywhere from first AE job (Jr.), to 3-5+ years of experience (AE), or 4-8 years of experience (Sr.).
Customer Success Manager (CSM); Focused on onboarding and enabling the client to use the product to create recurring value.
Account Manager; Often a former AE with 3-5+ years of experience who focuses on the company’s key accounts, or a role focused on driving new/more revenue from existing accounts.
Step 1: Basic Guidelines
- Keep it Simple. 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.
- Fair for Everyone. All compensation must be fair. Equal to everyone.
- Must be Easy. Easy to measure. Easy to administer.
Step 2: Start with Establishing Levels
Start creating three levels, think of these levels as 1) Entry level, 2) Baseline, 3) Experience/Top Performer.
NOTE: There is an organizational need for 3 layers to create a difference between an entry level position on one end, as people getting ticked off to see the lack of progress early on in their career. These micro promotions answer to their request and allows them to make smaller adjustments.
Step 3: Start with On Target Earnings
First start with the On Target Earnings or OTE. This is what the person would be paid annually and it has two elements; a base salary and a sales incentive held against sales, also known as variable etc.
NOTE: We recommend refraining from calling any sales incentives a bonus. A bonus is non-guaranteed and usually on-the-spot. An incentive plan is forward-looking with payment tied to the achievement of specific objectives that have been pre-determined and communicated to the employees that are on the incentive plan.
Step 4: Determine Base vs. Variable
The goal behind the variable is to develop a performance-driven culture in which your sales team is financially accountable for results. The ratio between the two is also referred to as leverage. A plan with a high variable in comparison to a low base salary is referred to as highly leveraged comp plan.
A highly leveraged plan sees you paying only for results. This, however, can create a lot of issues. Among them: you will not find senior sales people interested as the banking system will penalize the person during a mortgage, car loan, or getting any credit. Highly leveraged plans are mostly seen in transactional sales, where the volume is extremely high at low prices. On the other end, if the plan has little leverage, the sales person is less motivated to deliver against set goals.
The On Target Earnings can fluctuate per region and we strongly recommend you consult with a local recruiting firm.
CASE-IN POINT: Salaries for an AE as of Mid 2017
- Atlanta based AE. Base/Variable: $80,000 / $80,000 / OTE $160,000
- Denver based AE. Base/Variable: $75,000 / $75,000 / OTE $150,000
- NY/SF based AE. Base/Variable: $100,000 / $100,000 / OTE $200,000
Step 5: Target Setting
There are three models of target setting for a platform product with an ACV of $25k:
- Top-Down Target Setting: You take the number you wish to achieve, say $4M in ARR, you divide this by the number of salespeople, say 4 = $1M ARR/salesperson. You then divide the ACV per deal ($25k) = 40 deals won per year, or a little over 3 deals per month. The problem with this older B2B approach is that it is provides lack of predictability, and it is hard to measure where things go wrong.
- Bottom-Up Target Setting: You take “till date” numbers and use 80% of the best month ever as your guideline. For example, your Founder over the past year was able to close $800k in business at an ACV of $25k, so when hiring a salesperson, the target is set for $640k target. To hit the $4M target we need ~ 6 sales people. The problem with this model is that founder-based sales is not scalable, and it does not indicate the dependencies… what if you need 4 SDRs to bring this in, and 2 CSMs to bring on the client? You’d be making a loss. This is a common situation with today’s sales organization as the cost of acquiring a client have shot up radically.
- Business-Case Target Setting (Recommended): The sales acquisition team that sells a CRM platform uses one SDR ($80k), one Jr. AE ($160k) and ½ a CSM ($120k/2) to prospect/win and onboard 20 deals/month at $24k. This means that it costs a total of $300k. To make a profit this team needs to bring in at least $300k but we recommend 2x that number = $600k. 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
NOTE: There is a significant impact of Lifetime value. For example, within the FedTech space, SaaS contracts can be established with 3 years of commitment. This allows for a richer comp plan vs. a company with a 9 month LTV of a client (AdTech). We advise that with new products on which LTV has not been established to aim to not spend > 40% of year 1 revenues on the aggregate cost of SDR + AE + CSM at OTE. For the same reason we recommend for LTVs of 2+ years not to spend > 60% of year 1 revenues.
Step 6: Compensation of the AE
- 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
Step 7: Compensation during Onboarding/Training
It is hard to digest for any professional who earns $10,000 a month in commission to forego that for 3 months by coming to work for you. Thus it is quite normal for them to ask you to pay for this. The process to facilitate this is called a draw. In the example above a person doing $80,000 / 12 months = $6,667/month
- Draw: Commission paid upfront against the promise of performance. Think of it as a Loan without interest.
- Non-recoverable draw: You pay $6.67k per month. If they close $10,000 worth of commission you pay $3,333 extra
- Recoverable draw: You pay $6,667 per month upfront. If they only close $5,000 worth of commission the amount of $1,667 rolls over to next month.
- Clawback: In the above example the salesperson has to pay the company back $1,667. Clawbacks can be used against draws, but also against deals that commission was paid on but they churned following <3 months of use. These are often the result of selling to the wrong customer. It is not common to claw back if client churns > 3 months as this is deemed the responsibility of the CSM team at that point.
- Bookings vs. Cash collections: We realize this is a touchy topic as business in most rapid growth companies is risky, and a booked client does not guarantee cash collection. Here are some baseline thoughts to think through:
- Compensation against bookings accelerates deals, and is used during growth. Compensation on cash collections improves the quality of deals, and is commonly used during maturity.
- It is obvious that early stage companies do not want to hand out money, but compensating on cash payments doesn’t help. In particular:
- Delayed incentive results in lack of causality
- Hard to motivate a team on cash goals ~45 days after the deal closed
- Signals to top talent to ignore your company as “something must be wrong” (high churn)
- There are easier ways to ensure companies only pay against companies that paid:
- Claw-back the next month – deals that fell through previous month
- Adjust quota to accommodate for premature churn
- During onboarding/training: Length of a sales cycle up to 90 days. 90 days is the most common onboarding time. Noted that if you sell a complex security solution and you have no prior experience that onboarding can easily take 6-9 months. On the other end, if you are selling a Google plug-in you may need just a few days to onboard.
- Example of a Draw: Using a linear model, based on a compensation plan of 10% of sales based on $900,000, with a 90 day ramp, against a variable comp of $90,000/year or $6,667 per month.
- *Note: If it does not exceed the guaranteed draw ($2,500) the draw prevails and it rolls into month 4.
- **Note: In sales speak we refer to this along the bowling term “the bumpers are coming off”
- ***Note: Any sales professional in a start-up role will request a non-recoverable draw. This is valid as they are not aware of the risks they face, and in a hyper growth new role there is enough of it. Compare this to a more traditional sales role where the person takes over an existing/developed territory that brings in 80% of goal due to brand name recognition.
Earn the draw. Make your new employee “earn” the non-recoverable draw; here are a few ideas:.
Step 8: Compensation of the SDR
- 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 drives 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 payout $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 manager, $150 for a meeting with a CxO/VP title
IMPORTANT: The definition of an SQL and an 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 that you not only give examples of what is an SQL but also gives examples of what does NOT constitute an SQL.
- 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.
- Quality vs. Quantity
To generate a volume you can compensate on Sales Qualified Lead 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 the lead, 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, shift 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/
Step 9: Items to Include in the Sales Incentive Plan
- Monthly vs. Quarterly – The evidence is clear, monthly payments reduce the hockey stick effect in which 50% of all sales come in the last 2 weeks of the quarter. There are very few exceptions to this.
- Payment – 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.
- Capping – Refers to protecting 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 a common practice with companies in which strategic deals have a large team on it. For example, a Fortune 500 company may choose to deploy an enterprise wide solution following a series of meetings at of your CEO/VPs that AE was not part of. The AE should be notified that Capping may apply.
- Override – Any compensation plan 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.
- Fair Compensation – Sales has been an alpha-centric job for decades. Sales compensation receives, rightly so, scrutiny to be equal for gender, age, race etc. At the same time it is common practice for a VP of sales to bring in a former sales performer or Individual Contributor at an increased pay since they are a known entity. As another performer is let go, either to make room for the “top performer”, or due to underperformance, there is often some ground for a lawsuit. Note that regardless of the performance of the contributor, if the contributor was not fairly compensated during his/her tenure that there is ground for a lawsuit even if the contributor underperformed.
- Fair Compensation Board – Winning By Design strongly recommends portfolio companies >25 people to establish a Fair Compensation Board in which the CEO, and internal executive, an industry expert (often a board member), and an external HR professional agree quarterly to review compensation and ensure fairness. This protects not against hiring people at an insane compensation package, which rightfully so need to have an increased performance plan but also to allow for underrated top performers to be noticed and put on an accelerated career path.
Step 10: Write it down in a 2-page Contract with Mutual Commitment
- Annex A – Sales Incentive Plan Example
Revision Date: June 23, 2017
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.
- 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 leave 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.