Sales Compensation Plan – Draw Against Commission

When you bring a new sales representative into a territory, he will often ask about a “draw.”  The first time you hear the term, you may not know what it is or why it’s important.  A draw is a pay advance against expected earnings or commissions.  It can be important to both your sales representative and your company, but for different reasons.

Importance to Your Sales Rep

Selling high-priced, complex products or services can involve a lengthy sales cycle.  From first contact through the close of a sale, months may elapse.  The time needed to develop a fully productive territory can range from as few as three months to a year or more.  During this ramp-up period, your sales rep may experience severe personal cash flow shortages.  His or her base salary is usually significantly less than the total expected compensation plus commissions haven’t kicked in yet.  To help your sales rep get through this initial period, you may pay your rep a draw – an advance against future commissions.

Sales cycles can also be seasonal.  In the utility industry, energy demand is highest during the summer and winter months; it is significantly lower during the spring and fall.  As a result, companies that service the power generation equipment for utilities experience a well defined seasonal sales cycle.  Sales reps earn much greater commissions in the spring and fall months; summer and winter month commissions can be near zero.  Draws can help smooth out your rep’s seasonal cash flow in these situations.

The draw provides several benefits to your sales rep:

  • Provides a “living wage” during the period when a territory is being developed and commissions have not yet been earned.
  • Reassures your sales rep that the company has faith in his or her ability to be successful in the territory.
  • Smooths cash flow across seasonal earnings.

Importance to Your Company

As a company, you have two key interests when placing a new sales representative in a territory.  First, you want your sales rep to succeed, developing relationships and driving sales.  Second, you do not want to lose the substantial investment your company makes in hiring and training a new sales representative.

By paying a draw, you can help promote these interests.  The draw reduces your sales rep’s cash flow concerns.  Instead of worrying about meeting monthly cash flow obligations like rent or mortgage payments, your sales rep can focus on learning the territory, developing customer relationships and moving customers along the sales cycle.  Without immediate cash flow concerns, your sales rep is also less likely to look for a new job which is less risky from an income perspective.  The draw reduces your sales rep’s perceived income risk and keeps him or her focused on the job – selling your products and services.

Recoverable vs. Non-recoverable Draws

Draws can be either recoverable or non-recoverable.  Recoverable draws are loans against future commissions or bonuses.  Each month during the draw period, you pay your sales rep the draw amount. If your sales rep earns commissions that are less than the draw amount, you pay your rep the commissions.  However you only pay enough draw so that the commissions plus the draw total the amount of the full draw.   The outstanding draw amount accumulates from month to month.  When earned commissions exceed the draw, use the excess commissions to repay the outstanding draw.  Once the accumulated draw is repaid, all commissions are paid to the sales representative.

In the event that a sales representative leaves your company owing an outstanding draw, most companies will write off the outstanding debt.  It is very difficult, if not impossible, to collect monies paid to a departed employee.  Some companies will deduct the draw amount the sales rep owes from other amounts the company would normally pay, such as unused vacation, severance, etc.  However, before withholding benefit payments, check with a labor attorney to ensure you meet local regulatory requirements.

Non-recoverable draws are also loans against future commissions or bonuses.  However, a non-recoverable draw guarantees your sales representative a minimum level of income for each commission period.  If earned commissions are less than the draw amount, your sales rep receives the draw amount.  No accumulated draw is carried to the next commission period.

Recoverable draws are more advantageous for your company.  Non-recoverable draws are more advantageous to your sales rep.  There is a trade-off.  How much risk is the sales rep willing to accept to work for your company versus how much is your company willing to pay your sales rep?

Time Limits

Draws should have a time limit.  The length of the draw period should give the sales rep enough time to establish his or her territory plus the time needed to repay the accumulated draw.  Usually, this works out to one to two sales cycles.

Draw Amounts

The amount of the draw can vary by sales representative or by territory.  I generally look at several factors when determining the draw amount.

  • On Target Earnings (OTE) – What are the OTE for the sales rep?  An aggressive draw can bring the rep’s base salary plus draw to 85% or more of OTE.
  • Territory – What do I expect the territory to generate in revenue and commissions?  Based on this information, I may increase or decrease a planned draw amount.
  • Sales Rep Experience – How quickly do I expect the sales rep to get up to speed?  How much revenue or commissions do I think this particular sales rep will generate?  Again, using this information, I will target a draw equal to 65%-80% of my expectations.
  • Market Expectations – What draw amount and for what time period will it take to get the sales rep to agree to work for my company?  Depending on the competitiveness of the market and how badly I want a particular sales rep on my team, I’ll increase or decrease the planned draw amount.

As with all sales compensation issues, there are no right or wrong answers when determining your draw structure.  You need to consider the goals of your business, the level of risk (draw repayment) you are willing to assume, and how much competition exists for attracting the best sales team you can afford.

For more information, contact Wallace Management Group at (203) 834-0143 or email David Wallace.

© 2009, David P. Wallace

Subscribe to Top Line – The Sales and Marketing Blog by Email

175 Comments

  1. A draw is a loan from the company to the sales person. The draw is repaid to the company when the sales person earns commissions on sales s/he makes. Commission payments are reduced by the amount of the outstanding draw (repayment of the loan/draw). The purpose of the draw is to even out the sales person’s cash flow so the sales person can meet monthly expenses. Usually a draw is paid in increments that coincide with your paycheck. So, if you are paid monthly, your draw would likely be paid at that time in an amount equal to one-twelfth of your total annual draw amount.

    In your case, if the company paid you the full $16K up front when you joined the company and you repaid it in the first 3 months, you are not entitled to the rest of the draw for the year. That $16K draw would have been a loan against commissions that you repaid. On the other hand, if the company paid you $4K (one fourth of the $16K represented by 3 mos.) and you repaid $16K, then you should be paid the $12K commissions that were withheld from you. Finally, if the company paid you $4K in draw and you repaid that amount, plus were paid the balance of the commissions you earned, then you are not entitled to any additional draw monies.

  2. The January commission was paid in February, his employer had deducted the draw from the last week in December from this commission, since that paycheck was processed the first week in January. But there was no actual pay for hours worked in January. There were already four weeks draw deducted form Decembers commission, which was paid in January. I feel the draw being taken out of January’s commission is in error and I don’t know where to turn to get assistance with this issue.

  3. Carol,

    You need to go back and reconcile your draw checks with the commission statements to make sure they match up. Please don’t confuse “draw” with “base salary.” The base salary is for hours worked. It has nothing to do with draw. Draw is a “loan” against expected commissions. A draw has nothing to do with hours worked.

    If there was an outstanding draw amount when the January commission check was issued for commissions earned in December or earlier, I would expect the commissions check to reflect a deduction for the outstanding draw. The February check, however, probably had no deduction for a draw since all outstanding draw amounts were likely paid with the commissions issued in January.

    From what you shared with me, I don’t think the draw was taken out in error. That was draw paid in December against expected December commissions (which were paid in January).

  4. I was hired as an independent contractor with a draw… in December I was switched to straight commisoand my boss said since I was in the red that he was going to take out of my check monthly to pay back draw. He fired me on March 14th the day I was supposed to get paid and Leo my check. Also, next check he’s keeping to and then I’m sure he’s going to try and collect amount due. Our agreements was to take out of my check till he was paid back but unexpectedly he terminated me! I know he will have his attorney send me letter to try and collect. What rights do I have???

  5. Julie,

    I recommend that you speak with a labor attorney, or at least contact your state’s department of labor to determine what is and what is not allowed in your state with respect to draws and recovery of draws. Some states treat draws as wages (i.e., minimum wage) and they are not recoverable if you leave the company. Other states treat the draws as loans that you are legally liable to repay.

    Many companies will threaten legal action if you don’t repay the draw, however, in many cases that’s bluster. It really depends on how much outstanding draw you have and what the company’s cost will be to recover it. Lawyers, even for the companies, are not free.

  6. I work commission-only sales. I also receive a draw each pay period based on number of hours worked with taxes withheld. I repay this draw s commissions are earned. I received a W2 showing income that was commissions plus draw received. There is nothing showing the draw income that was repaid. Shouldn’t that draw repayment be deducted from my income for income tax filing?

  7. Hi. Thanks for the great article Mr. Wallace.
    My question is this, am I obligated to pay back the draw that was paid to me over the last 7 weeks. I was working as a w2 employee on a draw towards commision basis, being paid $700 a week with a local business in FL. We agreed to part ways amicably as I was mislead on what the job expectation would be however there are several projects that are ready to close, so I have given them all associated paperwork for the clients that I met with and I have not made contact with the clients since I left. However, now I am finding out that they are slanderizing my name, stating I am trying to steal their clients and I received a message from the owner demanding that I pay back the draw that was paid to me. Do I have any legal rights here or should I be concerned with their threats? Any advice would be greatly appreciated.
    Thank you

  8. Sue,

    Yes, your draw income should be offset by the draw repayment. Check to see if the commissions reported on your W2 was net of the draw (already reflects the repayment). If not, speak with the accounting department (controller or CFO) at your company and ask them to reissue your W2 or explain why your W2 over-reports your income.

  9. April,

    Apparently your company or the sales rep who assumed your accounts is annoyed at something. It might be something you did or did not do. Or, it may be that the new sales rep is under a lot of stress and throwing you “under the bus.” I suggest you have a conversation with your former manager (or owner of the business) and try to learn why they are mad at you. You might offer to have a conversation with your former customers if they think that would help them close some deals.

    In any event, you should also talk to your state’s labor department and find out what your rights are relative to draw repayment. Some states, and I don’t know if Florida is one of them, treat draw as non-recoverable compensation in the event you leave the company.

  10. Worked as a sales rep in 2015 and quit part way through the year. My commisions were paid up front so I filed them with my 2015 taxes. I no longer work for commission with my new job in 2016. I was billed in 2016 and paid back $500 of my commissions from 2015. How do I deduct this as a loss when I have no commissions to deduct from in 2016?

  11. Erik,

    Please check with your accountant. You should be able to treat it as a business expense or a reduction in income for 2016. However, I am not qualified to provide tax advice. You need to verify my thoughts with a qualified tax expert.

  12. David

    Do you have a template (Excel) that shows the draw / commission structure and or how to use it? Where could I find one if not?

  13. My last employer said I was being paid hourly or draw, which ever was higher. I never understood the math they used, even after asking about it several time. My coworkers had the same issue. My employer, said we would be paid when cabinets were delivered. We recieved 50% deposit when order was place. The employer started paying us half our commission for half the month then the second half the second half of month. This was never the agreement. Then later I discovered they were taking a draw against commission if we had been paid an hourly wage the pay period before collecting the commission. We were paid twice a month. We were also never told that we would have our commission subtracted from profit on job, so that our commissions percentage would be lowered. I never recieved a commission statement. I also found out that they were receiving bonus checks from the companies we purchased cabinets from and were never informed and this was never added as the profit on the job. We were also offered spiffs from the granite company we refered our customers to and our employer said that they needed to take 50% of the amount.
    Do I have a case if I go to the labor commissioner iny state of NV.?

  14. Does it matter how Salary & Commissions are reported on your pay stub? For example, my draw amount is reported on the pay stub as Salary. The commissions that I earn are not paid out until my draw balance is paid back. Thus any future commissions I am paid. So is Draw salary?

  15. Grant,

    I do not have a spreadsheet template to track outstanding draws and commissions. Generally, these types of spreadsheets are specific to a compensation plan.

    You can Google “Draw Commission spreadsheet” or “draw commission tracker” and find some pretty generic models.

  16. Your situation demonstrates why it’s very important to have the terms of compensation agreed upon in writing. Your commission plan should define how you are paid, what constitutes commission, draw, salary and hourly compensation.

    I don’t have enough information to say if you are being mistreated or cheated, but the labor commissioner in your state may be interested in your story.

  17. In the long run, all your compensation will be subject to Federal, State and local income tax based on where you live. In the short run, salary and draw payments are subjected to different tax withholding rates. The withholding rate on salary is usually based on your annual salary (i.e., 12 times your monthly salary = annual salary). The withholding rate on your commissions and draw are usually set at a lower rate, often 20%. The reason for the lower rate is that commissions can be variable, so it’s harder to estimate your annual income based on the amount of each commission check.

    To answer your question, draw is not salary. Draw is a “loan” to you that is repayable with future commissions earned. However, if your draw is not fully repaid by the end of the year, the IRS might treat the outstanding draw you received in the current year as earned income. Please check with your accountant to confirm this.

  18. Great article!!
    My question is when on “draw”
    Comp plan, am I obligated to work a 9 to 5 work schedule??

  19. Nestor,

    Because you are on a draw, do not feel constrained by a 9 to 5 work schedule. You should feel free to start much earlier than 9 am and work well past 5 pm. Do whatever you need to do to make your target numbers, repay your draw and maximize your earnings.

    Sales is not an hourly or 9-5 job.

  20. Do you happen to have a template employee contract copy we as owners could use as a guide for a draw?
    Thanks!

  21. I am owed $68,000.00 commission and have a loan against commission of $32,000.00. I live in GA and my employer will not transfer my $32,000.00 to income and deduct off my $68,000.00 due to he does not want to pay the payroll taxes on the $32,000.00. The company is in a bad financial situation and if I was to quit or the employer file bankruptcy will I need to pay the $32,000.00 back or will this amount be written off the commission owed. I feel like I am being trapped from leaving the company.

  22. My husband paid into his draw 27,000 but only received 24,000 as of his end date:
    He is fully commission and this is his money he is borrowing against himself.
    He just got his last pay check and they took 2,700 for the draw. Year to date says paid into 27,000 received 24,000. Since his time with the company is over shouldn’t he get back the 3,000 ? New York State:

  23. I recommend that you contact a reputable labor attorney in your area. Different states treat draw against commission differently. Some states, such as New York State, treat the draw as compensation. Your situation sounds a bit shady given your employer’s financial situation. An attorney may help you get your money.

  24. Based on what you’ve shared, it sounds like your husband is owed money. However, I would need to see the entire agreement. New York State has well-developed compensation laws addressing commissions and draws. I recommend that you speak with a specialist in the New York State Department of Labor who can guide you. Alternatively, speak with a labor attorney licensed to practice in New York State. She should be able to guide you with a quick consultation.

  25. Below is sample language covering draws that I have used in sales compensation plans. Please review this language with your own attorneys as different jurisdictions (states, provinces, countries, etc.) have local laws that determine how draws are treated as income and how companies can recover draws. For instance, in New York State, draws can only be recovered against commissions and, if an employee leaves the company with an outstanding draw, it is not recoverable.

    Draw

    Employees who participate in this Plan may request and receive, at the sole discretion of the Vice President of Sales, a recoverable draw for a limited period of time. The purpose of the draw is to provide a minimum level of compensation until the sales representative establishes a regular commission flow. Individual monthly draw amounts may be changed or eliminated at any time at management’s sole discretion.

    Outstanding draw amounts carry over to following months without limitation. Draws are recoverable against commissions for the period while the Sales Representative remains in that position with Company. Company limits a Sales Representative’s maximum outstanding draw to the equivalent of XX times the monthly draw amount. Company limits the maximum draw payment period to YY months.

    Repayment of Draws

    Commission payments earned will not be paid until they exceed the cumulative draw. The obligation to repay the draw amount is ongoing and is not limited in time. However, should the employee become ineligible to participate in the Plan for any reason, the draw amount is repayable in full, less commission payments earned to date. Company has the right to recover any amounts owed the Company by the employee from the employee’s base salary or other sources.

Leave a Reply

Your email address will not be published. Required fields are marked *