Sales Commission Arrangements – How to Increase Revenue and Lower Liability

Linking Sales Commission to Sales Performance

When you put the proper sales infrastructure in place, you will motivate your team and your company will be poised and ready to grow revenue. But not all sales commission arrangements will get the job done. Careful thought and planning are required to craft the right sales commission arrangement for your company and its sales force.

Below are the 5 key issues to help you create the right sales commission arrangement for your company:

1. Be Precise

Too often, sales commission arrangements do not have the proper precision and detail. Remember that salespeople are smart and skilled at working the system. Your sales commission arrangement therefore needs to be very specific about the types and levels of performance that will result in corresponding sales commissions and related compensation. If there is an angle, loophole, or argument to be made by a salesperson to increase compensation, then there is a good chance that you are going to hear it from your sales team. Analyze your proposed sales arrangement from different angles and points of view, in order to determine what sales behavior it will motivate and how it might be interpreted under varying circumstances.

2. Keep It Simple

You might lose some salesforce motivation if the underlying sales commission arrangement is too complicated or convoluted.  Err on the side of simplicity, so that there is a more direct causal relationship between desired sales activity and resulting sales compensation.  Also, a complicated plan may have unintended consequences when the sales team decides to focus on certain aspects of the plan that you did not anticipate, believing that those aspects may increase their chances for greater compensation.

One way to keep it simple is to base the sales commission on top-line sales revenue. When compared to a sales commission based on EBITDA or other profitability measures, the top-line sales revenue method only has one moving part – the sales revenue generated by the salesperson. The other profitability methods include many components that the salesperson cannot control or change in a meaningful way, so there could be a reduction in sales motivation, as well as increasing frustration if there is a disconnect between the salesperson’s perceived efforts and results and the related compensation received.

In some cases, however, it might make sense to use gross profits (i.e., revenues minus costs of good sold) generated by a salesperson as the trigger for sales commissions, if there are a number of products to be sold and you want to encourage sales of a more profitable mix of products. This type of sales arrangement will require information systems and procedures that can track and analyze the necessary sales information, as well as properly crafted language in the sales commission agreement to cover the more complicated arrangement.

Also, be careful when offering sales commissions to teams of people. Unless there are clear guidelines regarding how commissions will be split among team members, you are setting yourself up to have dissatisfied employees and possibly legal disputes. If possible, make sure that your company has the final say to determine how commissions will be shared.

While simple is good, too much simplicity can get you into trouble. For example, an agreement to “pay 3% on sales” leaves open many questions and issues, including:

• whether sales are gross sales or net sales;
• whether the commission percentage is the same across all products and services;
• whether there is a commission reduction for sales returns or refunds; and
• how and when commissions are paid (and stop being paid).

3. Have a Hard Stop

The sales commission arrangement and related compensation to the salesperson should have a hard stop. At times, we have seen sales commission arrangements that provide a perpetual commission on all sales to a particular customer or on all sales of a particular product or service to that customer. If your company becomes successful, then this type of perpetual commission arrangement could become too rich and affect future transactions of the company (e.g., the economics of the arrangement could deter a future purchaser of your company). Be careful and put a hard stop in place.

In most cases, the sales commissions should not extend beyond the term of the salesperson’s employment. In addition, you should consider limiting the sales commission to, for example, a percentage of first-year sales (or specific product or service revenues during the first year). If necessary, you could add a sliding scale for lower percentage commissions during later periods after the first year, but only to the extent these additional commissions make good business sense.

4. Put It in Writing

Ambiguity is not your friend. Common sense and good business sense dictate that you should document the sales commission arrangement in writing, with your company and each salesperson acknowledging and agreeing to the terms and conditions of the arrangement.

Not surprisingly, many states require written documents, as well as signed acknowledgments. Either prepare a global sales commission plan with related acknowledgments/agreements for execution or one-off agreements for each salesperson.

Set expectations. Improve sales management. Comply with the law. Lower likelihood of disputes. Put it in writing.

5. Keep It Legal

Now for the fun part! A sales commission arrangement unfortunately is not a “back of the napkin” type of transaction. In addition to the above points, it is necessary to comply with the important legal matters, including, among others:

• When commissions will be paid, as some states require a minimum frequency of payment;
• State and local wage payment laws, including when and how commissions are earned and to what extent deductions can be made from resulting wages;
• Internal Revenue Code Section 409A requirements relating to Deferred Compensation arrangements (i.e., structure the commission payments to fall on specific commission payment dates with the short-term deferral period under Section 409A);
• Qualification for exempt employee status and related payment in accordance with applicable law, including requirements to pay minimum wage and overtime; and
• How to handle payment of commissions upon termination of employment.

Your Turn:

Which of the above tips saved your bacon when dealing with the sales team? Let us know to help other entrepreneurs go and grow.