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

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46 Comments

  1. dear mr wallace: i am a manufactures rep. my product takes a long time to sell sometimes 18 months. in 2010 the company paid me a straight draw. there were no sales. early in 2011 the account was opend and the purchse orders have begun. immediatley the comapny has begun deducting my draw from commissions. here is my question: was the 2010 1099 income? was it a loan? how do i book it withthe irs? how will i book the repayment in 2011? please offer me any assistance on this subject. i will find out a way to return the favor. thank you. bobmac

  2. Bob Mac, As a manufacturers’ rep, I assume you work as an independent contractor as your own, separate legal entity. Given that status, there are a number of ways that you might account for the 2010 1099 income. I recommend that you consult with your accountant to ensure that you account for payments in a manner that is both legal and appropriate to your particular financial situation. — Dave

  3. Mr.Wallace,

    I am a Financial Advisor and have been in the business for 3 years and have been doing very well with the firm that I am employed with. I currently work on 100% commissions. I receive a 36%-40% payout of gross commissions. I have been contacted by a very prominent Local Investment firm that would like me to work for them and would like to structure some type of draw against commissions and I was looking for some guidance of how much to negotiate as a draw. My Total comp for 2010 was $86,000 not including profit sharing or health insurance benefits. Projected 2011 $100,000. Should I target $86,000 as my draw since that is what I made last year and as I transition some of my own clients over to the new firm that I could eventually remove the draw against commissions? The firm is aware that I really wouldn’t be willing to switch Firms unless I could realistically double my current income. Thanks for your help. Adam

  4. The question of what’s an appropriate draw against commissions depends on your perspective. From the employer’s perspective, the employer wants to pay as little draw as possible, but still provide its employee with enough cash flow to be able to focus on performing the job. So, if an employee needs $5K per month to meet basic needs (health insurance, food on the table, transportation to work, perhaps a portion of mortgage/rent), then I pay that amount. If they can manage with less, then I pay less. The key is to meet basic needs, but still keep the employee hungry enough to do better. If the employee is too comfortable, there may not be an incentive to drive more sales.

    From the employee’s perspective, you will want look at whether the draw is recoverable or not. Plus, look at what the draw is recoverable against. If the draw is non-recoverable (i.e., you get it no matter what and you don’t have to pay it back at the end of the year or if you leave the company), then ask for as much as your employer will give you. There’s no risk beyond being viewed as greedy, needy or otherwise a high-maintenance sales person. This will allow you to focus on developing sales and not worry about money.

    If the draw is recoverable, then you will want to look at the mechanisms for recovery. Is it recoverable against future commissions (most common)? Base salary? Expenses? Other monies owed to you? On demand (unsecured loan)? In this case, you need to determine how much debt you are comfortable carrying. Also, what is the likelihood of earning commissions that exceed the draw and when will commissions surpass the draw amount?

    Given what you’ve outlined below, I would target $86,000 for the draw (they may or may not agree to this amount). I would also negotiate for the draw to be non-recoverable for some period of time (6 mos? 12 mos?) based on a realistic period you need to transition your client base. Thereafter, you and your employer may agree upon a draw amount, recoverable against commissions, that smoothes out cash flow until you are established.

  5. Dear Mr. Wallace,

    I was recently terminated after only 3 months with an employer who established an at-will base+ draw compensation package. The sales goal for the first quarter was overly ambitious, but I agreed to it because I wanted a new opportunity for growth. The employer and the job was not a good fit, and I did not meet my sales goals. My employer terminated me, even though I had 2 proposal meetings scheduled including one the very next week. He held my last paycheck to put against my draw, and has been harassing me about the remaining draw. I reviewed our agreement, which stated that draws not met in the first quarter would be taken from my base compensation, but there is not language about re-payment after termination. I strongly believe that I do not owe this amount as it was an unfair work environment (in the CEO expected me to also perform marketing functions for the company in addition to attending time-consuming meetings with his sales coach). I also learned after leaving that this CEO has a reputation for being difficult to work with, and even abusive. Does he have any legal recourse for making me pay the remaining draw?

  6. Don,

    Compensation and commission issues can vary tremendously from agreement to agreement, employer to employer, and state to state. I don’t know the specifics of your situation beyond what you have provided. I am also not an attorney.

    If the disputed or withheld amount is significant, I recommend you contact a labor attorney, particularly one with expertise handling compensation issues in your state. After reviewing your situation, your attorney will be best able to advise you.

  7. If a company decides to change marketing strategies for inside reps who make commission based on leads provided by the company, should the company offer a draw against future earnings or non-recoverable ramp to compensate for the change in marketing? My company is deciding to head up-market, now involving much longer sales cycles, RFPs, etc. The risk and reward are both potentially much higher. We could make a lot of money, but are all afraid that without the SMB deals we were dropping in routinely we won’t get paid much for a while, and draw money we have to pay back means a loan, essentially, against what may turn out to be a bad marketing strategy, or one that needs refinement over time. I feel like we did not do anything wrong, and the company should, in good faith, give us non-recoverable money to compensate for lost commissions in this fallow time. Even a true-up number would work, where we would be able to sell and if we fell below a certain number they would make up the difference for the short term, until we see how the new strategy works out. Your thoughts?

  8. You put forth good reasons for a non-recoverable draw. The bottom line depends on several factors. First, how valuable is the current sales team to the company? Are you generating sufficient revenue and margin for the company? Are you helping the company achieve its objectives? How much would it cost the company to replace you if you leave? Second, how is the market for sales reps who can replace you? Will the company lose market share or sales if you leave? How quickly can you be replaced? What would be the cost to train a replacement? Third, what is the culture of the company? Is the company paternalistic where they would take care of you during the transition? Is the company cut-throat where it’s survival of the fittest?

    I understand that this economy is challenging for many sales reps. It’s challenging for companies too. Whether or not a draw is put in place, and whether it’s recoverable or non-recoverable will depend on your company’s financial position and its culture.

  9. Dear Mr. Wallace – I signed on with a company back in July of 2011 and negotiated a draw against commission for a ramp up period of 90 days since the sales cycle could be lengthy and commissions would not be enough to substantiate my finances for a while. The agreement was a base salary plus a guaranteed amount per month (draw) for a period of 90 days. I stated in the interview that I wanted an unrecoverable draw. There was never discussion of repayment of the draw. I would never have agreed to such a thing and politely declined the job offer. I have never and do not believe in a recoverable draw. It would be impossible to ever catch up if you were required to pay back a draw. The 90 day period passed and my commissions had thankfully kicked in and I was able to transition nicely without financial hardship. The past 3 months I have attained over 100% of my target sales goals and am on target to reach 200% in January. I am their top sales manager at this point in the month, so I have contributed quite substantially to this company and performed above expectations. On the last paycheck of 2011, Dec 31, I saw that they had deducted over 2k from my check and called it “draw”. I was horrified. I had not been notified of, nor had there been any discussion of terms of repayment. I was put in such financial hardship by this event as I was expecting to pay some Christmas bills with the extra commissions I had earned for the holiday. The next check they took even more out. I never agreed to repay nor was I ever told when or how they would deduct this 7k in draw that they say I now owe them. I have no idea what to do. How can they just take it out without notice or my agreement? Is that legal? What is my recourse? Why would a company do that to a top producing sales manager? Thanks for any insight you can provide.

  10. Mr. Wallace, I have worked for my current employer for 10 + years and since 2011 they have been paying us on a 100% commission structure in a sales roll. They give us a weekly draw against and then at the end of the months sales, deduct this draw against from the commision paid. ie: 60, 000 in sales gives me $6,000 less the draw. They are only paying vacation pay on the amount given after the draw???I live in Canada/in Ontario…is this right??? I inquired and they said , I only get commision on the amount they pay after the draw against, yet they deduct my draw against the full amount from my 10% commission??

  11. There are a few routes I suggest you explore to determine if you have legal recourse against your employer. First, review all notices and documentation provided to you by your employer when they switched to the 100% commission structure. Read all the large print AND the fine print. Did they state explicitly how they would treat vacation pay? Do they pay you an amount equal to an average of commissions earned over time? Second, check with your province’s department of labor. The province or federal government may have laws that define how vacation pay must be treated by your employer. Third, consult with an labor attorney. Review with him or her all the notices and documentation. Your attorney should be able to tell your quickly whether or not you’ve been wronged.

    As an employer, if I was paying my 100% commissioned employee vacation pay, I would pay on an average of commissions earned over a recent period such as a month, quarter or year. I would not pay on the draw amount. The draw is a payment to smooth out cash flow so that sales reps can make their personal obligations (rent, mortgage, car payments, food, etc.). For high performers, the draw is normally much less than their commissions. Therefore to pay them for vacation at the draw rate would be short changing them. For under performers, the draw is normally much more than their commissions. To pay them a vacation rate at the draw level would be to overpay them. The under performer should spend the vacation time looking for a new line of work, because he or she is likely to be let go soon.

  12. Dear Mr. wallace,

    I am in commercial roofing sales. My title is Project Manager/ Sales Representative. I was hired with a salary of 50,000/year aprox 8 months ago. Back in April I was told I was going on 100% commisions. The deal was presented as follow: I would continue to receive my weekly pay of $961.00. I was told that I was able to continue with my weekly pay amount because of my sales for the previous three months, or the first quarter(not quite sure which) I found it curious that they switched me with only two month remaining in a quarter, although its probably no coincendence that I had sales in excess of 330,000 in the month of April. I woukld have made 6-7 percent of the gross sale based on the profit margein and where the job comes in. The dollor amount would have been 16,000 to 19,000. Nevertheless, In May and June i had sales of 130,000 and 119,000 respectively. Back to the way it was presented; I would stay at my regular wekly pay but now it was a draw. At the end of each quarter we would “settle up”. Last quarter I generated aproxikately $600,000 in sales, yet on the 13th of july I was told I was now only going to be receiving a draw equal to minimum wage at 40 hours a week, which is equivalent to $248 per week. My job doesnt pay for gas unless you sell over 100,000 in a month, and then it is just an allowance of 500. I spend 180 a week in gas. that would leave me less than 100 dollors a week to live on. I dont know what to do. The sales ccyle is realisticaly 120 days at best 60 to 90, Yet they are analizing my sales on a weekly basis, which would be appropriate if the sales cycle for our product was 1 day. How do I get them to be reasonable. They offer little to no training. Am I being forced out.?

  13. Steve,

    I don’t think you are being forced out, but I do think the owners of the company are re-evaluating how much they are willing to pay for new business. Or, they may be trying to manage their cash flow in a seasonal business.

    You need to have a frank conversation with management and come to agreement about how much the company values your contribution. Include everything; salary, draw, guaranteed minimum income levels, commission rates, timing of commission payments, mileage reimbursement, expenses, other benefits (health insurance, paid vacation, holidays, sick time, disability insurance – long-term and short-term, life insurance, personal days, working hours, etc.). Then, put everything in writing to ensure that both parties understand the agreement and commit to it.

    When this is done, you may find that you receive compensation in areas that you were not aware of (benefits). Or, you may find that your compensation is not what you need or find fair. At this point, you need to decide if that job at that company is good for you.

    When you negotiate (and this is a negotiation), define the value you bring to the company. How much revenue do you produce? What is the profit on the jobs you bring in? How much did you grow the business in your territory since you were hired? How much business was the company doing in the same territory before you joined them?

    Also, what other business can you bring to the table that the company might be interested in? Gutter cleaning services? Chimney repair? Clearing snow and ice from roofs in winter? The roofing business can be a seasonal business in some parts of the United States. If your compensation is 100% commission, your income will fluctuate seasonally as well (the company’s revenues will also rise and fall with the seasons). By identifying other work your company can do during the off season, you may be able to generate a smoother income for yourself.

    Dave

  14. Dear Mr. Wallace,

    Please help me understand the following in my impending employment contract (please note I am new to commission sales jobs):

    In the original contract…$50k as a draw against commissions. Co pays commissions at a rate of 12% of sales booked and shipped. To get started, the Co will absorb the first 90 days of draw against commission salary as a way to ease into new structure. At the end of each subsequent calendar quarter, the company will pay you any excess commissions earned over the draw amount already paid.

    In the counter, not knowing, I countered the following to request a lesser draw of $40K and a more detailed explaination of this process works. Here is the reply…I can discuss this in detail when you are here but basically, each year stads as a whole. We allow payments on a quarterly basis so that you can enjoy your commission checks and the company doesn’t end up owing a large year end payout.
    For example on a draw of $50k per year, you will need to have sales in excess of $416,667 per year to generate excess commissions. Each quarter, if you have generated more than 1/4 of that amount, a commission check will be issued. If you fall short one quarter, that shortfall must be made up in the following quarters before a commission check is issued. Again we can discuss this in detail once you are on board.

    Is this clearly written? If the sales don’t reach the goal will I be forever in debt to this co.? How does a company come up with this formula? I’m not sure of how my goal and draw work, please help.

  15. The draw against commission program that your employer has outlined looks reasonable and generous. Basically, your employer is evening out your cash flow. Commissions can vary in amount based on how much you sell each month. What your employer has offered is to provide you with a draw of $50,000 per year, paid in regular installments (bi-weekly or monthly is normal). Think of it as base-line income. At the end of each quarter, your employer will compare the commissions you earned in the quarter with the amount of the draw you received. If you earned more in commissions than you’ve been paid so far, your employer will pay you the additional commissions he owes you. If your earned commissions do not amount to what you’ve been paid, then the difference is carried over into the next quarter.

    You are correct that if you don’t sell enough so that your commissions exceed the draw, you will be further in the hole in the next quarter. If you continue to not sell enough, you get further in the hole. However, your employer is likely to change your draw or end your employment before the hole becomes too deep. Your employer has hired you to sell. If you don’t sell, your employer will replace you with someone who will sell at the levels they need to make their sales goals. But keep in mind, it’s costly for your employer to keep hiring sales people who can’t sell. Your employer wants you to succeed. It’s in their interest.

    If your employer decides you will not be successful in a sales role, then he has a few options. First, he can fire you and demand that you repay the draw you were paid, but did not earn with commissions. This is a real possibility, but often it is a futile exercise since you don’t have a job and likely don’t have much money. Second, he can move you to another job in the company. In this case, he may or may not try to recover the shortfall in commissions. It depends on how hardnosed he wants to be. Third, he can fire you and forgive you the owed shortfall in commissions, considering it a cost of doing business.

    Finally, you may decide to leave the company and sales position when you are uncomfortable with how far in the hole you’ve become. If you leave owing money against a draw, your employer will likely try to recover the shortfall against other monies he owes you, such as expenses. He may also ask that you repay the shortfall immediately or over time. He may even enlist a lawyer to sending official-sounding dunning letters. This will be particularly true if you leave to join a competitor.

    In any case, before you sign up for a program that makes you uncomfortable, consult with a qualified labor lawyer. A little money spent now may save you a lot down the road.

    In the end, ask if this is the right career path. If you are uncomfortable with a draw, then perhaps sales is not right for you. Sales demands someone who is confident in their skills and ability to sell. If you don’t think you will sell enough to surpass the draw, then ultimately you may not be successful in the position.

  16. Dear Mr. Wallace,

    Thank you so much for your reply, it clearly explains the position of sales and draws. Your advice is very helpful and will help in my decission making process.

    Most Grateful!
    Ruth

  17. Dear Mr Wallace,
    I am an independent contractor for a company who has agreed to an “enhanced commission draw” verses a “base commission draw” for the first two years of my contract. I will be coming up on my 1st year anniversary in January however I have been offered a great opportunity with another company I would like to pursue. For the first 6 months of my contract my draw was $5000/month and 4 out of 5 months I exceeded that amount in commissions earned, but never had the draw deducted for the months $5000 wasn’t made. In the next 6 months my draw was $2000 and I have exceeded that amount monthly. Per my contract it states that if I am to quit within the first year, I would owe 30% of the “enhanced commission draw” paid to me for the first year, which “both parties agree represent the difference between the enhanced commission draw and the base commission draw.” Nowhere in my contract is either “enhanced commission draw” or “base commission draw” defined nor is a formula provided. Also, on my actual commission schedule provided my the company it does not call my “monthly draw” at “draw” it refers to it as a “garauntee.”
    I spoke with a previous employee who left the company and he said he was charged 30% of all draws even when most of his commissions exceeded his draws.
    Do you have any insight as to how this could pan out should I leave before my 12 year anniversary?

  18. Kelly,

    You state that you are an independent contractor. As such, I assume you are working independently. You set your own hours, schedule, etc. As an independent contractor, you are also free to take on other contracts to develop your business, provided they are not competitive with or violate the terms of your other contracts.

    However, your responsibilities and obligations to your current company should be spelled out in your contract. You need to read that carefully to know exactly what you are accountable for. In many cases such as yours, I recommend having an attorney (preferably a labor lawyer or a contracts lawyer) review your agreement and advise you what your options are.

    I don’t know how iron-clad your contract is, especially with respect to draw. The previous employee may have succumbed to intimidation by the company without really having to do so. Have an attorney look at the agreement. Let your attorney tell you if the definitions for enhanced commission draw and base commission draw are in place. It sounds like you may have some bases for negotiation, if not outright walking away from the deal. However, don’t take my word for it. Review your contract with your attorney. It will be money well spent and it may well save you a lot more than it costs you.

    Dave

  19. David,

    I own a staffing firm. One of my employees in currently on a draw (or what we have both called a draw). At this time he is way ahead of his draw (his earned commissions this year are at least double his total draw amount), but he is still receiveing the draw. How is the draw supposed to work, when the salesperson is ahead? It would seem to me that the draw would stop for a while. Is that correct?

    Jay

  20. The purpose of the draw is to help smooth out earnings. This may be necessary either at the start of a sales person’s tenure in a territory (new hire, change in territory or responsibilities) or when there is a long time period between commission payments such as annual or semi-annual commission payments. Effectively, draws are no-interest loans from the company to the employee. Draws are repaid with earned commissions. In other words, paid commissions are equal to earned commissions less outstanding draw. Don’t pay twice by paying both draw and commissions.

    For a sales person starting in a new territory or for a new sales hire, the draw is normally set at a level to enable the new sales person to meet expenses or otherwise afford to build the territory while in the start-up phase. Draws are usually set at a level that is less than targeted earnings. The draw period should approximate the length of time you expect the sales person to become fully productive. The draw also shows good faith on the part of the company that they are confident the new slaes person will become successful. When the new person’s commissions consistently exceed their draw, the company can end the draw payments since they are no longer necessary. If a draw has been guaranteed for a specified period of time, say the first six months or year, draw payments may be suspended during months where commissions exceed the draw, but reinstated later when commissions are lower.

    When commission payments are paid annually, semi-annually or even quarterly, draws may be used to help the sales person maintain an even cash flow between commission payouts. The draw amount might be a specified monthly or semi-monthly amount, a percentage of expected commissions, or a percentage of estimated commission run rate. In this situation, companies may continue the draws indefinitely because their sales people need the cash flow to meet their basic needs such as mortgage, car payments, groceries, etc.

    In any event, the draw should be repaid by successful sales people through the commissions they earn. If your company does not expect the commissions to exceed the draw payments or if the company does not recover the draw payment from commissions, the company needs to make a choice. Either fire the sales person because they are not meeting your sales goals or reduce the commission payout percentage and convert the draw to a base salary.

  21. Mr. Wallace,

    I am negotiating a position with a company and we have discussed several options. We are looking at a sales position paying a salary + 8% commission (based on total sale), originally I was looking to make the sales and maintain the customers for repeat business. Now they are looking to pay a much lower commission for a period of time and I turn over the customer, they are also looking to lower commission by same amount that something would sell below a set gross margin. (Ex: If the gross margin is 30% and the sale was only 27% they would lower commission by 3% – does not seem apples to apples) I would prefer keeping the customers and nurturing those relations and doing repeat business. I am now looking at some other options, can you give me your thoughts on the following questions.

    When considering a commission, which is better a percent of total sales or a percent of gross margin?

    How much commission seems fair in a 30% gross margin sale? Let’s say based on a 2 million dollar sale.

    Have you heard of being a contractor making your own schedule working on a draw at 100% commission, yet getting benefits + expenses?

    To me it makes more since to pay a commission based on gross margin not total sale, and I was thinking to maintain a fair adjustment to recommend the commission percent be the same as the gross margin. (Ex: 30% gross margin on 2,000,000 = 600,000 = commission of 30% = 180,000. If 20% gross margin then commission 20% etc.) This would be compensation for landing the client, closing the deal and maintaining the client. What are your thoughts?

    Thank you,

  22. Ragan,

    Your prospective company appears to be focused on growing its business by acquiring new customers. I suspect that the company is also fairly young and new. The company principals are confident that once the customer is on board, they will be able to develop the relationship. They want you to find more prospects and close them.

    Generally, companies pay new business representatives or business development reps a combination of salary and commission. The salary is necessary to compensate for the long sell cycle associated with new business. Alternatively, a company may pay its sales rep commissions only, but at a significantly higher commission rate. Account representatives are generally paid at a lower commission rate (% of revenue or % of margin) since they can generate more volume from an established customer.

    To answer your questions:

    Commission as a percent of total sales vs gross margin – either scenario works. The smart company will adjust its commission rate accordingly. For instance, if the gross margin for new customers runs at 60%, then the company will be indifferent if it pays commissions at a rate of 10% of revenue or 16.67% of gross margin. In both cases the company would pay an average of $10 for every $100 of revenue. However, most sales people prefer to be paid a percentage of revenue since they directly control the revenue they generate. Gross margins may be affected by factors outside the sales reps’ control.

    How much commission is fair to pay depends on a number of factors. Factors include new customer vs existing customer, new product vs established product, commissions paid in the industry, is the company breaking into a new market, is a base salary paid, experience of the sales rep, are expenses paid, etc.

    With respect to contractor status, the IRS and individual states provide guidelines to help a company determine if a worker is a 1099 contractor or an employee. The following information is from the IRS website,

    Facts that provide evidence of the degree of control and independence fall into three categories:

    1.Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
    2.Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
    3.Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
    Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another.

    The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination.

    Tying commission rate to the gross margin rate is an interesting thought. It would certainly motivate you to drive business with higher margins. However, your employer may prefer to use commissions to drive behaviors other than maximizing gross margin. Your employer may want to pay different rates for new customers, product introductions, market penetration, balanced product portfolio, etc.

  23. Hello Mr. Wallace,

    I would like to thank you for responding to my questions.

    Overall I agree being paid commission on revenue makes more since, however since they are now trying to create an adjusting commission based on meeting a 50% gross margin I was trying to think outside the box. The 50% margin is high for this company and few people reach it. I don’t mind a challenge, but the adjustment does not seem apples to apples.

    Ex: Let’s say on a 1 million dollar sale my commission based on revenue is 10%, however they want to be able to adjust my commission lower by the same percent that a sale is below their target of 50% gross margin. So if the sale were to come in at 40%, I would not get a commission.

    That is why I was thinking out of the box and tying a higher commission based on gross margin and having it automatically adjusted with the gross margin.

    Any other last thoughts on this?

    Again, thank you for your response.

  24. Ragan,

    I have two thoughts here.

    First, when setting up a commission plan, I prefer to provide positive incentives. In the case you describe, I would pay commission that is in line with industry norms for deals that are in line with industry norms. However, if I strive to achieve better than industry norms, I might offer a commission “kicker” for attaining certain milestones. In the case you outline, I might pay 8% for sales with margins between 45% and 50%, but pay an additional 2% for deals over 50% margin.

    Second, the company should always have the right to reject a sales opportunity. If the sales person lands a deal with unacceptable margins, say under 40%, then the company can simply refuse to accept the deal. However, if the company accepts a deal with low margins, then that becomes the company’s decision. The sales rep should still be paid.

    Dave

  25. Dave,
    Thank you for taking a moment to read this, any input is greatly appreciated.
    I recently left a company after working for 22 months as an independent contractor. I started in January, on a non recourse draw (pay based on $30,000 a year) for 6 months. At the end of this sixth month period, per the contract I signed, it switched to a recoverable draw.
    The typical sales cycle with my job is 24 months and thus had no commissions come in the door during 2011, so when 2012 came around and I received the tax form for 2011, it only showed my income as roughly $15,000 (the non-recourse draw). When I asked my controller why it did not show the full amount I received ($30,000)I was told that I will not pay taxes on draw until commissions come into the door. At the time i recently left, no commission had made it into the door yet. While I had around $40,000 accumulated in draw when I departed, the company will not be pursuing me for the money owed.
    My question is, will I pay taxes on this $40,000 of draw I received during 2011 and 2012? I believe I read that if a company forgives the debt, then it is considered a gift. At that point, the company would pay taxes on that amount, not me. Thank you very much for your help.

    Will

  26. Will,

    You pose an interesting question. “Is a draw that you have been paid, but not earned, considered income by the IRS?” My initial reaction is “Yes, the IRS will deem draw that you have been paid to be income.” Similarly, draw that you repay may be considered a reduction in income. However, I am not a tax accountant. I recommend you contact a tax accountant or qualified tax advisor and ask for their opinion. You can also pose your question directly to the IRS via telephone or by visiting a local IRS office. Here is a link to the IRS contact web page.

    Dave

  27. David,

    I have a small business with two admins. I have been handling sales since I started the business but am stretched in so many directions now as I am owner, bookkeeper, sales, customer service and banker you get the picture. I think I need a full time dedicated sales person to get above the number we have been stuck at for a while. However, not much money to offer them other than an aggressive commission. I have tried extremely aggressive only plans and don’t get any bites or have had two people waste my time for a couple weeks and then quit. I goggled draw compensation and found your site. As the employer if I offer a recoverable draw against commission it sounds like I might attract more candidates to apply? Do you know of any templates or calculation examples that may help me come to a conclusion the plan?
    Thank you
    Darren

  28. Darren,

    I understand the challenges you face. Generally, an aggressive commission-only plan will attract unemployed or under-utilized sales reps who are desperate to generate income. If they don’t start making money right away, or if they get a better offer, they will leave your company in a heartbeat. A draw against commission will provide a starving sales rep with some degree of security and staying power. However, you need to be realistic in your expectations. How long is the sell cycle? What is the size of the market? Who is your competition and how do you stack up?

    I recommend that you read through the other postings on my blog about sales compensation. I cover many of the issues you are facing. You can find them at http://www.wallacemanagement.com, then select Sales Compensation Plans on the left side bar.

    Dave

  29. Hi, we started a successful business magazine in Roseville and Rocklin Calif. There was none in these cities and they are growing and have so much to offer. Ours is a very quality high end Free Magazine and we are in our 6th issue, we are bi-monthly and are in over 100 selected locations with a current distribution of 10,000. The magazine has taken off and we were just 3 trying to do everything. The publisher is a graphic designer who is very talented and I work as everything else, sales, writer etc. We have a pt ad rep that helps. I just recruited a top not ad sales rep from another local firm. We want to offer a nice commission structure with a base based on his sales. We have lots of leads to give to him that we cannot get to, there will be no cold calling, he also has lots of clients of his own.
    He currently works for another company and we want him to work for us as an independent contractor. I would like to offer this to him with a draw against commission compensation letter.
    First, I would like to ask you, what are the benefits for him to work as an independent contractor vrs working directly for a company. Second, do you have an example of a offer letter of compensation against a draw I could work off of. Thank you so much. I have learned a lot from this website and reading all your replys.

  30. Congratulations on the success of your magazine! It sounds wonderful.

    First, make sure that the ad sales rep you are considering bringing on as an independent contractor is truly an independent contractor. The IRS and individucal states each has very specific requirements that define an independent contractor. If you do not satisfy these requirements, then your rep is viewed as an employee. When you have an employee, your company is required to pay additional payroll taxes to cover the employee’s benefits such as Medicare/Medicaid, unemployment insurance, etc. If you hire a worker as an independent contractor (i.e., 1099 employee) and they are later determined to be an employee by the IRS or state department of labor, then you may be liable for penalties and back taxes. You can find more information at your state’s labor department web site and at the IRS web site.

    That said, the advantages to the independent contractor can be many. First, they work for themselves, controlling their own schedule and resources. They are able to take more business tax deductions for legitimate, business-related expenses than an employee normally can. Independent contractors can and often do work for more than one company (just make sure you protect yourself from competitive conflicts). The drawbacks for a rep working as an independent contractor may include, no benefits such as paid time off, health insurance, etc. Some people embrace the freedom and upside afforded by being an independent contractor. Others prefer the security associated with being an employee.

    With respect to sample offer letters, I suggest you Google “offer letter draw against commissions.” Many examples are presented. Once you have drafted your letter, I recommend having an attorney review it to ensure that it offers what you think it offers. I find offer letters can be very personal and specific to both the company and prospective hire.

  31. David,
    I am currently looking to change companies and am looking for thoughts on what I can demand for my perspective new companies. I’ve been a top sales rep at my current company for 10 years and have unfortunately “hit my ceiling” as a sales rep. Even after crushing my quotas month after month, year after year, my company can no longer pay me what I rightfully earn. I have several competitors interested, but this is my first time negotiating with a new company, and I don’t want to sound too demanding, or risk selling myself short. I read your article above and have been toying around with numbers but would still appreciate your perspective. My current salary is $58,500. Monthly car allowance $400. With my commissions and bonuses, I am averaging total gross income of $175,000. Each competitor will be offering a non-recoverable draw plus salary. What is a fair amount to request for a draw? I am getting the impression that they want me to present them with offers, where do I even start?

    Thanks for you insight,
    Shawn

  32. Shawn, You pose some good questions. What is a fair draw? How much draw can I reasonably ask for?

    Negotiations are all about ranges. When negotiating a draw, your employer will work from the lower end of the range. You, on the other hand, will want a high draw (assuming it’s non-recoverable). If the draw is recoverable, you will temper your greed for more money now with the knowledge that you will have to pay it back in the future.

    So, the employer will likely want to pay you a draw that will provide you with the ability to pay your rent and eat (small meals). He will be looking to pay you a percentage of your expected commissions, perhaps 20%-50% depending on total expected income. If commissions are expected to be high, then the draw percentage will be lower.

    You, however, will likely begin your negotiation for a draw that will maintain your earnings at the level of your previous compensation. Nobody changes jobs for less money, if they can avoid it. Therefore, you will want to negotiate a combination of salary, draw and benefits that will maintain the earnings or cash flow you are leaving behind.

    I the case you outline, I would negotiate for a combination of salary, draw and benefits (including car allowance) that keeps me at the $175K level. I would also negotiate for a car allowance on top of that, preferably one that is more than your previous car allowance. You may need to settle for a lower amount, but you need to evaluate if the opportunity is worth settling for less.

  33. I’m new to the world of sales (and sales compensation), but am interviewing for a sales role. The salary negotiation is next week. Based on the discussion above, I wonder “why do companies go through the hassle of a ‘draw?’ Doesn’t it work out the same as increasing your base salary as a percentage of your total comp? Is it a tax thing?” Thanks for your informative article and answers so far.

  34. The first time you look at a draw versus a salary, they do appear to be very much the same. However, there are significant differences that benefit the company. The first one, as you’ve hit upon, is taxes. If a draw is fully recoverable, a company may be able to treat it as a loan and therefore not have to pay employer taxes on the draw itself, although taxes would be due on the commissions paid against the draw. Other benefits for the company of a draw include performance incentives and integrity of the overall compensation structure. With a draw that is recoverable against commissions, the sales person must continue to perform in order to earn his or her commissions. With an increased salary, monies are paid regardless of performance. An increase in salary does not allow the company to recover the increase against future sales. With respect to the integrity of the compensation structure, a draw allows the company to pay higher salaries to more senior level sales reps. However, if the base salaries are increased in lieu of a draw, then the differential between senior level sales reps and more junior reps may decrease. This can cause personnel problems within the organization.

  35. Mr. Wallace:

    I have been in commission sales most of my life. I worked at a company from feb 2012 to june 2012….they paid a small salary until commissions started. They have just reached out to me via a social web site asking me to repay the draw they gave me….they never gave me any copies of any employment documents…..I do not recall it being a draw….the company attorney even reached out to me via a social web site asking for the draw back….again I do not recall being a draw…can they do that?

  36. Beth,

    It sounds to me like the company is grasping at straws trying to claw back its “draw” after eighteen months. Contacting you via a social web site is also highly unorthodox. I assume they do not have any other contact information for you. From my perspective, I think you have three options.

  37. Ignore them and see if they go away or escalate. It’s possible nothing will come of it. Or, they may become more aggressive in contacting you in which case you will need to address the problem more actively.
  38. Ask the company for copies of documentation that demonstrates that the small salary they paid was really a draw and that you agreed to this in writing. They should be able to produce an offer letter or employment agreement that states the situation clearly.
  39. Contact an attorney who can review the company’s claim and advise you on how to handle the situation. An attorney can also represent you in any legal action that may follow.

    The option you pursue may depend on the amount of money at stake. Given that it’s a small amount, an attorney may not be worth your while. It may also not be worthwhile for the company to pursue if they would recover less than it would cost them to pursue it.

    The above thoughts are purely pragmatic advice. Do not view this as legal advice in any way. Only an attorney can provide you with legal advice.

    Dave

  40. Hi Mr. Wallace,

    I am being persued for a capital equipment sales position. They are offering an unrecoverable draw for $3,000- $4,000. monthly. I am nit sure for how many months. It’s 100% commission. It is a lengthy sales cycle. I am new to not having a base salary. There are a lot of unanswered questions I havem Please advise what I should negoiate to insure I do not end up in the hole. Tx. Kathy

  41. Does an employer have to give you advanced notice before lowering your draw? I have been in my sales position for 9 years, never in deficit. My home base relocated last month, and in the transition I fell into deficit for the first time. I was informed today in my review that my draw would be lowered and it would take place in the pay check I am scheduled to receive in three days. Hardly a notice if you asked me. I plan to call Human Resources, but I would love to know if there are any laws protecting this kind of action on their part. Thank you in advance for your help.

  42. Kathleen,

    If you want to ensure that you do not end up “in the hole,” then you want to negotiate a non-recoverable draw or a draw that is only recoverable against commissions.

    If this is not possible, then you need to look at the position, market, opportunities and compensation plan carefully to be certain that you can realistically earn enough commissions to cover the draw.

    Dave

  43. Christine,

    The amount of notice that a company must provide before lowering your draw may vary depending on the compensation plan agreement (what do the T’s & C’s of the sales plan say) and state laws. Given your positive nine-year history with the company, however, I suggest that you first speak with your manager or the head of sales for your company. The notice may have been simply a bureaucratic procedure that was fulfilled when you went into a deficit. They may be able to address the problem without a big fuss. If the company still does not budge, I recommend you contact a labor attorney to explore your options.

    Dave

  44. Hello my name is Becky and I work for an television salary is draw and since the beginning I was never informed of my sales goal each month they change and I do not know what they are till the end of the month and by this time I am in the hole as my boss states I am in the red a communist. In any case my draw is1,200 a month but I have months where I have 10,000 or more and then told there is no commission all the money belongs to the house this month barely started and today I already got a notice that I am a communist I have already put in the books 7,000 what should do please explain my commission was to have been 12,000

  45. Hello Becky.

    My understanding of your position from what you have written is that you work on a draw that is repaid from earned commissions each month. Commissions appear to be tied to quota achievement. However, your monthly quota changes each month and you do not know what the quota is until the month is complete. As a result, even when you think you have had a good month, you are still short of quota and wind up earning less in commissions than you were paid in draw for the month. As a result, you are in the red. (By the way, the phrase “in the red” refers to accounting, not communism. When a business is profitable, then they are said to be “in the black” because all reports are shown in black ink. When a business is unprofitable, they are “in the red” because the negative numbers are shown in red ink. Red ink is used to show negative results so that they stand out visually. This way the managers can focus on the problem areas.)

    I recommend that you do several things. First, you need to read and thoroughly understand how your commission plan works. Read all sections of the plan including the terms and conditions (fine print). Do not stop after reading the percentages or dollar amounts you earn based on revenue, profits or quota attainment. It’s all important. Second, you need to know what your target (revenue, quota, profits, etc.) is for each month before the month starts. Your sales manager should provide you with this information in writing. If you know the target in advance, you will know how you are doing against the target during the course of the month. Also, by having your manager provide the target in writing in advance, they should not be able to change the target to suit their needs. Finally, you need to sit down with your manager and have a frank conversation about what it will take for you to succeed and not be in the red. While you’re at it, let him know that you don’t want him to call you names, like “communist,” any longer.

    If you cannot accomplish these steps, I suggest you start looking for a job with a more reputable employer.

  46. I quit my sales job a month ago and now they mailed me a letter saying I had to pay back my draw not covered against commission. I know it was in my contract that i would have to repay the money against future commissions but i dont remember it saying i would have to if i quit. I had problems with my direct supervisor not assigning leads theat he was giving others so when I spoke to them today I reminded them of that and told them that I don’t have the money they are asking for. They responded by cutting the number in half. Is that them just looking for something rather than nothing or do you think they are actually cutting me a break? It’s still about 3k, do you think I can ignore them or should I just go right to a lawyer?

    Thanks,
    Jeff in New Jersey

  47. You give some great answers.

    I have been on a $40k salary+bonus as an outside sales rep for two years. I like the company but was extremely annoyed when I brought in $9MM in prospective accounts and didnt end up getting any bonus because the closing team only pulled in $1.2MM and I got bonused 1% on what came in over $2.5MM.

    Shortly thereafter I had a “discussion” with my boss and he wanted to switch my pay from $40K salary to $24K draw with a complex commission structure. I protested because the closing team was only actually closing 15-25% on the dollar for accounts I was bringing in.

    I got a sales assistant which helped me with the sales calls I couldnt find time to make and together as a team we in a 3 month period brought in $3MM in prospective accounts. Again the closing team bungled it and only brought in $200K during the period.

    I then got called into my bosses office and again got raked over the coals for only bringing in $1.2MM in the past 5 months, and now the draw against commission model is being thrust on me and I don’t have much choice it seems either than just take it or claim constructive dismissal.

    My previous sales targets were $5MM/year in new business. In order to repay the $2,000/mo draw I would need to be personally responsible for $4MM in closed business. By my metrics of the closing team’s performance, I would need to bring in around $22MM in prospective business just to tread water and pay off the draw, and perhaps another $18MM in prospective business to even come close to what I am making in salary today.

    I worked on commission before for this same boss at another company and proved my abilities by bringing in $11.5MM in business in two years taking a salary of $18K+commission to an income of $54K so I am somewhat insulted by this move. I understand that there are cash flow issues but they are hiring two new staff including my (no longer) sales assistant and using this in part as justification for needing to free up cash flow.

    I have tried to explain to my employer that it is not fair for me to be judged on the numbers that the closing team closes and actually gets money in the door because my job is to bring the prospective clients into the sales process, but getting no dice. For example I brought in a great $1.2MM prospect that should have been a walk in the park but closing team only landed $200K. Also I fear that there is no motivation for the closing team (who are paid salary plus a percentage of recurring revenue) to close the accounts in full and as quickly as possible, and also maybe even motivation for my employer to delay closing the account if he does not want to reduce cash flow by the amount of my commission, and I will be left perpetually paying down the draw.

    What would a good negotiating strategy be on this? In a way I would like to see some sort of financial incentive if I bring the closing team a great prospective client, they do a full proposal and the client declines, even if this is only say a 0.1% non refundable credit against my draw. I also think the commissions are a bit low. 0.6% on new business whereby when I was on $18K salary+commission it was more like 1-1.5%.

    I feel the offer is a bit aggressive and almost hostile. I like the people I’m working with and for but I’m afraid I’m going to go from $40K salary down to struggling to repay the draw and having the accumulated draw eat up any commissions I receive because of the long sales process and the closing team’s weak abilities to land the deals I bring. For me to just tread water and pay off the draw I would need to perform like a rockstar.. nobody brings in $22MM in prospective clients in my business in a year. My metrics might be a bit off but I’m basing them on the closing team’s past performance. Just last week a $900K account got flubbed and I had the guy ask me for the meeting in person and hand me his details.

  48. Jeff,

    You need to take a close look at your employment agreement and review it with an attorney. Laws vary by jurisdiction and draws vary by company and agreement. Only when you have all the facts in writing will you be able to determine the best course of action.

    Dave

  49. Taylor,

    You are in a very difficult position. From what you describe, the problem could lay with either you or the closing team or both. Whatever the situation, your manager is not doing a very good job of analyzing the situation and communicating a good path forward to the parties involved. First, take a look at the problem. You are delivering a lot of opportunities, but the closing team is not executing on them. The questions I, as a manager, would have are: (1) what is the quality of your leads? Are they well qualified? Are they real leads or just contacts who said “give me a proposal” just to make you go away? It sounds like you need to spend more time understanding what it takes to truly qualify your leads. (2) Why is the closing rate so low? Are the closers on the team following up on the leads? They may not be if you are not sufficiently qualifying them. Are the closers trained to ask for the order and close the deals? Are the closers doing the work the company pays them to do? Do the closers have too much on their plates?

    I suspect there is blame enough to go all around. You need to speak with your manager to get to the root of the problem and develop a solution, not just bemoan the unfairness of the situation to you. Solutions may include better training for you on qualifying leads, better training of closers on lead follow up and closing, hiring more closers is they are overworked, better management of closers if they are not doing their jobs, etc.

    An alternative solution might be for you to take on a more complete sales role where you both find opportunities and close the initial deals. With an expanded role, you will certainly know if your prospects are well qualified.

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