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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68 Comments

  1. Thank you David.

    I wrote to you in the intial frustration of the offer. I intended to hammer out a deal that worked for both me and the company and negotiate. However two days ago I went into the office and learned that my pay had been cut unilaterally and that I had no option to negotiate – I was pushed onto the draw.

    You are right – this is something that I contemplated. In order to ensure the deals close and have some control over my compensation it might be an idea for me to take over the closing process – but I would need to gain a higher percentage.

    You are also right on another point, that if I am frustrated with the closing team’s performance I should be compensated for the activity that I generate. This was what I was attempting to negotiate with my boss (who is on the closing team, so it is difficult to tell him his closing ability sucks), that perhaps when the prospect produces statements that I be compensated perhaps a small amount (say 0.1% of their 0.6% offer) once the prospect allows them to make a proposal, with the remaining 0.5% forthcoming on the close. This would at least put the closing team on the same page in that they would be partially paying for the lead at full value, so they had better get in gear and get as much of the money as they can up front.

    As I see it the mismatch in this offer that makes it absolutely terrible is this. I will not generate commissions on accounts under $250K. They are offering me half commissions on greater share of wallet brought in after the initial close. Yet they have a pattern of only being able to close a small amount up front and taking months or years to gain the share of wallet. In one example a $1.2MM juicy account that should have been a walk in the park they only netted $200K – which would have meant I would receive no commission at all. As they gain the rest over the coming months I would be paid half once they exceeded $250K. The closing team is paid in recurring revenue on all existing accounts, they can afford to wait, and in this deal they are literally incentivizing their own poor front end performance on the close.

    So I am looking to make a lateral move within my firm to another group or to move to another firm altogether.

  2. Hi,
    I’m new to sales the salary is only $24,988 but,for 6 months i will be on Probation Period $200 of salary will be against the draw based on a 15% commission on sales—-i’m confused on all this- i have had different people tell me different things so,what does this mean?and is it a good or BAD thing?thanks

  3. From what you tell me, it sounds like $2400 of your annual base income is draw. That means the first $200 of commissions you earn each month goes toward repayment of your draw. With 15% commission on sales, you will need to sell $1334 of services (ad spots?) each month to cover your draw. If you sell $2500 in the month, you will earn $375 of commissions. Of this, $200 will go toward repayment of the draw and you would receive a check for $175. Only if you sell more than $200 every month will you earn more than your $24,988 base.

    A couple of questions you should clarify are:
    – Is the draw recoverable or non-recoverable?
    – What is the period against which the draw recovers?
    – What is the draw recoverable against, if other than commission?

    What these questions mean are, can the company recover the draw against anything other than commissions? Does a draw shortfall carry over from one month to another (at this level, I don’t think it should, especially if you salary is already at least $24,988 per year) or if you don’t make enough commission in a month to cover the draw, will that month’s shortfall be “forgiven”? What happens to the draw shortfall if you haven’t yet earned enough commissions to cover the draw and you move to a new position or leave the company?

    Generally, a draw is good. It helps even out your cash flow across sales cycles. You just need to be careful that you don’t wind up with a debt you can’t repay. Whatever you do, I advise against signing any promissory notes against the draw.

    Good luck and sell well!

  4. Hi,

    I am currently on a draw. At this point I am $1500 over my draw (company owes me this much). Just recently I found a new job… If I quit will I receive that commission as I rightfully earned it?

    Thanks

  5. A normal interpretation of “draw” would indicate that the company owes you the money you’ve earned over and above the draw. However, you should review your employment agreement to confirm this.

  6. Thank you for the reply. Its a small company so the employment agreement was more verbal.

    I appreciate you taking the time to answer.

    Nick.

  7. I just left a job owing $1300 in draw. The company is requires to give me at least hours worked at $9.00/hr which is my draw. I received my last hourly paycheck which is paid weekly as a draw but this week (a week after I quit) I received a $40 paycheck that shows that I had $385 in commission where $345 was taken in draw. When leaving a company with commissions owed to me but draw owed to the company, am I entitled to any commissions earned even if I owe more in draw. My commission checks are paid 3 weeks after the sale. I asked why I even received $40 and they could not even explain that to me.

  8. I’m am on a 1099 draw for 2014 and never realized a commission and still “owe” the company for the year. I am wondering do I pay taxes on the company loan even if I am liable to pay it back in 2015?

    Thanks!!

  9. All commission arrangements are different and often individually negotiated. It sounds like your state has minimum wage laws that apply to hours worked without earning commissions. Your company should provide you with a full accounting of commissions earned, draw deducted and hours worked.

  10. You will need to check with an employment attorney or tax expert in your state to get a definitive answer to your question. Alternatively, you can check with the IRS. However, I believe the IRS counts the draw as income and you are liable for taxes on the draw. However, don’t take my word for it. Check with an legal or tax expert.

  11. I would imagine your correct David and thanks for your input. Amazed I would pay both the irs and the full amount back to the company as well. Meaning I would essentially pay double tax!

  12. Thanks so much for the in depth details that were given in this article. I am persuing a new job in the sales market and this helped to give me good general idea of Draws v. Commission. Very Helpful!

  13. Dan,

    Follow up with your accountant, but I don’t think you would pay double taxes. When you pay your company back for the draw, you also reduce your earned income by the same amount.

    Dave

  14. Dave,

    This is by far the best info on draws that I have found – thanks for posting. My dilemma is that I joined a company as a sales rep and received a non recoverable draw. After 1 month, I have decided that this role is not the right role for me for multiple reasons, and considering tendering my resignation. I am being told that I will have to pay back the non recoverable draw. The draws are paid monthly and I believed it to be a guarantee (income) so I had no expectation to pay the draw back. My employment letter stated the draw was payment in advance of commissions but didn’t state details relevant to repayment if I were to leave. Do I have to pay the money back??

  15. Stacey,

    Each state and jurisdiction has its own laws and regulations governing wages and labor. Commissions and draws can come under these laws. You will need to document and pull together all your communications between you and your employer, both leading up to your offer, the actual offer and during your employment. Also, if possible, document how other reps and their draws have been treated. Then, consult with an attorney in your area who specializes in labor or compensation law. It sounds to me like there are several gray areas in your agreement.

    Dave

  16. Okay, I receive “BASE+” and the commissions breakout thusly:
    20% of Net, after $20,000 (no commish on first $20,000)
    Assuming I did $500,000 profit for 2015, how is this figured process A or B ?
    A] $500,000 – $20,000 = $480,000
    payment = $480,000 x 20% = $96,000

    B] $500,000 x 20% = $100,000
    payment = $100,000 – $20,000 = $80,000

    Obviously, there is a significant difference

  17. Both methods for calculating commission are valid. Although the first method (A) is more common. However, you need to go back to your written sales compensation agreement. Does it state that you are paid 20% of profits after the first $20,000 of profits are earned? Or does it state that commissions are calculated from the first dollar of profit, but that commissions are earned and payable only after the first $20,000 of calculated commissions are achieved?

    Scenario A assumes that the company needs to recoup $4,000 of what they’ve invested in you before paying commissions. This translates to $20,000 of revenue. Scenario B assumes that the company needs to recoup $20,000 of what they’ve invested in you, translating to $100,000 of revenue.

    I can see it both ways. The key is what’s in writing!

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