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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202 Comments

  1. I am not aware of legal limitations or restrictions around an annualized draw plan. However, I am not an attorney, so for a legal opinion, please speak with a lawyer, preferably one in your area with expertise in labor law.

    In my experience, though, companies will design draw programs in many ways. Generally, they are trying to (1) attract sales talent, (2) demonstrate faith in the sales rep while they build a book of business, (3) help even out cash flow for the sales rep throughout the selling cycles, and (4) minimize the risk exposure to the company in the event the sales rep is not effective at selling their product.

    Depending on the length of the sales cycle in your business, your company may be trying to cover any one or all four of the points above.

  2. I recommend you consult with an employment attorney in your state to best understand the company’s obligations to you as an employee. The situation you described does not sound right. I’ve never heard of any company clawing back earnings, much less 2 years’ worth, from a job you had already been compensated to perform.

    Were you buying a territory? Were you buying customers in the territory? If that’s the case, then there should have been a written agreement in place.

    Please consult an attorney who can advise you of the legal ramifications of your situation.

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