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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134 Comments

  1. Hi,
    I came across your site when i google a specific line in my company’s contract. I would really like some clarification and you seem to be the best person to go to! So here goes.

    I am currently on a draw and receive the same amount each month. I was told when i started that i needed to “pay back” that amount BEFORE i received any commissions. It has changed a few times since in the last year (my boss was once very generous and didn’t stick to the contract and found herself in a world of hurt) so now we must abide by the contract that commissions will be paid out after a “placements” 6 month date. We guarantee our clients a 6 month probationary period. The confusing part. I have earned 70K in total commissions and earned 50K in total draw in this 1 year period. However because only 40K of the total commissions have earned their 6 month period I have been told that i am 10K BEHIND and need to beat my draw (at that yearly date) in order to receive any commission. I was told that if at the time of our last paycheck was 50K and my total “6 month” commission was 55K then i would receive only 2K (subtracting the $3K that i get monthly from my draw).. Clearly in favor of the company and one sided but does that stipulation of the “40-50K mathematical equation” need to be in our contract?? The famous line to which i found your site is this “Company will pay Employee a draw (as a non-refundable advance against any Commissions) “.. Please any help in explaining this would be much appreciated. As it looks now, November, i need to continue to make not only $3K to pay back my “draw” but then 3-5K on top so that i can balance at zero by June and then hopefully be consistent in placements over the next 6 months so that i can actually start getting paid what little commission i have brought it. Which will be my 2 year mark.

    thank you for taking the time. I can see that i’m not the only one with this question.
    Key

  2. David,

    I am in the process of negotiating a comission agreement with a new employer. This will be my first commissioned sales position, so I have a rookie question.

    Can I ask to have the commission structure guaranteed for period of time? If so, how many years is reasonable?

    Thanks!

  3. Hi. I am the VP of Marketing for a printing company. I was just wondering how Much a draw should be. I’ve brought in our Company in the first year, over $150,000 in sales. Anyway I am paid hourly plus I get commission every two weeks, if I hit over $1500 in sales & collecting in 2 weeks. Anything over 1500 is when my commission kicks in at 20%. For Instance: Collected $3000- minus the $1500 (draw) =$1500 left x 20% commission= $300 for me.
    I make $12 an hour at 60 hours every 2 weeks. Which is $720 gross in 2 weeks. My draw is $3000 a month. ($1500 every 2 weeks) My base pay is $1440 a month. Is the Draw supposed to be more than double my base pay? If I collect $1000 I don’t see a dime. I actually have to sale and collect over $5000 in 2 weeks just to get a decent commission. So my question is how much should my draw be every 2 weeks? I am the #1 Sales Rep too. Other Reps don’t have a draw. They too get base but + straight 20% commission. And I am the only Sales rep with no other duties. Any suggestions would really help me. Thank you.

  4. There is no formula for how much a draw should be. However, there are some factors that go into a business person’s decision to set a draw. These include:
    • How much does my sales person need to meet their basic living needs, such as rent, food, car payments, etc., and still sell for my company?
    • How much can a sales person realistically make selling my company’s services and earning commissions under the compensation plan?
    • What other benefits am I providing to the sales person (i.e., health insurance, car allowance, expense account, etc.)?
    • How long will it take a new sales person to get fully up to speed in the territory?
    • How much revenue or margin (profits) do I expect my sales person to generate, now and when fully engaged?
    • How much do my competitors pay their sales people?
    • How much do I need to pay my sales people to ensure that they don’t leave for other opportunities?

    The bottom line is that negotiating a draw is like negotiating a salary and other benefits. It’s between you and your manager (or VP of sales or company owner, etc.). The relationship needs to benefit (make sense) both of you. You need to know that the company is paying you fairly and earning opportunities are realistic. The company needs to know that you contribute more value (profits) to the company than you cost (base + draw or commissions + benefits).

  5. Johnny,

    Yes, you can ask for a guaranteed commission. This is called a “draw.” Draws can be guaranteed for any period of time, although they are generally set for the time it will take for you to get up to speed in your territory. How long will that take? Given that you are new to sales and, I assume relatively new to the business, I would set the draw period to last 2-3 times as long as a typical sales cycle. So, if it takes a rep 3 months to close a deal (initiation through final sale), then I would set the draw period for a minimum of 6-9 months. The longer the draw, the more faith your employer has in your success. Keep in mind, that you earn either commissions or draw, not both at the same time. The amount of commissions paid is offset by the amount of the draw paid.

    Also, when negotiating your draw guarantee, I recommend that you have the company guarantee your draw on a monthly or quarterly cycle WITHOUT carrying the outstanding draw amount into future periods. Each new cycle, your outstanding draw amount should reset to zero.

  6. I have a question for you. I work in sales in Indiana and if a customer pays with a credit card over 500.01 we(sales reps get charged a fee for the customer using their credit card for payment. Example the total amount was $8963.50 with a gross profit of $4925.05 the fees added up to $269.10 my commission for that was $246.35. Is this legal for them to take money away from us sales reps because the customer wanted to pay with their credit card?

  7. Heidi,

    Many companies pay commissions on net sales or on the margin (gross profit) of the sales. What you describe is a way of paying commissions on net sales. Net sales is equal to gross sales minus discounts. In the case of credit card fees, they may be considered a discount on the sales price. Therefore, commissions may be calculated on the revenue the company receives after the credit card fees are taken into account. I see nothing illegal with this arrangement, but it should be spelled out in the compensation plan.

    Please check with your state department of employment or labor for definitive regulations in your area.

  8. I was with a real estate company for about two months when a medical emergency in the family caused me to leave. I was on a recoverable draw and had yet to earn any commission to begin to pay the draw down. My questions are about whether I’m required to pay back the draw. In the offer letter and contract I signed, the draw was said to be paid back through commission. I was to go through a probationary period of four months during which time I would receive the draw. After four months, I would begin to pay down the draw with any commission I earn. There is no language about what happens if I leave the company before I earn commission. The owner wants me to pay back the draw. Without that specific language in the contract about how to pay back the draw, am I required to do so? Also, the company is based in one state, I live in another, and did all my work in a third different state. Are there different laws about recoverable draws, and in my situation, which state would have pre-emption?

  9. Hi
    I have a insurance client who hired two sales people. He hired one on commissions and salary, the salary was to manage the sales people, the commissions he paid a draw for almost 3 years trying to give her time to start earning enough commissions to pay the draw back, each month the commissions were put into payroll and the net was taken back to pay the advance back, of course the employee quit leaving an outstanding advance of $24k can we 1099 the employee for the advance? Next employee was just commission sales, but also received advance to live on, left company owing $20k can we 1099 the employee or do we need to put into W2’s

  10. David,

    I have a question on commission payments. This is for named accounts. Typically if there are annuity type sales in the named account before a new rep takes over would the new rep normally receive the ongoing commission payments? Commissions are paid monthly based on Gross Margin. In addition, if the rep has a Gross Margin goal do you think the Gross Margin amount (monthly) would go towards this goal?

  11. I’m looking at going to a lot thats offering a $2000 draw and comission of $200.00 per sale regardless of selling price. This seems odd to me. Since a vehicle may cost more than 50,000, how would that fall under the min 15 percentile. I live in ca.

  12. My brother works at a dealership and his weekly draw is $400, say he accumulates an outstanding balance due to this draw and is unable to close a deal and eventually leaves, will he owe the dealership the outstanding balance?

  13. I have a sales rep with a non recoverable draw. My question is, does the clock reset after one year? My rep wants to start the new year with new sales going against the draw but the prior year commission he gets paid in the new year. I have always reset the clock and any prior years sales commission that comes in after the new year goes toward the new year draw.

    My only reservation is that he is a long term employee and probably isn’t going to leave the company so I’m thinking I will help him out. Thoughts?

  14. Our company hires 10-99 sales reps in retail/event style environments. Can we do draws for 10-99 reps? If so, how would it differ?

  15. If the employee doesn’t cover the draw with commissions over the calendar year, how does that impact future years? WE have an employee with a 20k draw. Our commissions are 20% so he needs to exceed 100k to get past the draw. He billed 78k in 2015. What is appropriate for this year? Should he have a cleaned slate or should the threshold now be the 22k he owes for 2015 + the 100k for 2016? He is a valued employee and we think he has potential.

  16. Are there tax implications that make the draw more attractive than having several big commission checks throughout the year?

  17. I work on 100% commission and receive a 500.00 weekly draw, which is paid back from future commissions. I can not understand why my commission is used to pay back a draw for holidays when the store closed, or when I am expected to attend an informative vendor seminar for a day or even 2 or 3. I work for a retail store that also manufactures. The sales force owes their draw for their Christmas day off (..Thanksgiving, Easter) while everyone else gets paid holidays. How is this legal? Thank you!

  18. Check with your tax advisor about tax implications of a draw versus commission checks. In the end, there should be very little difference. The draw serves to smooth out your cash flow while commission distributions can be very lumpy (feast some months, famine others).

    The only time I can think that a draw would affect your tax situation is when you are earning your commissions in one tax year and being paid the commissions in the following tax year. In this case, your draw would serve to increase your income in the year when your tax rate is lower and reduce your income (commissions minus outstanding draw amount) in the year when your tax rate is higher. However, I think this situation is likely to be less common. As I said, check with your tax advisor to review your particular situation.

  19. You can do draws with 1099 reps as well, but you’ll have less leverage recovering the draw if they don’t produce. Before providing a draw, you will want to check their credit risk or view the possible loss of the paid-out draw as a cost of doing business.

    As with any compensation agreement, review your plans with an attorney to ensure you’re in compliance with state and local regulations.

  20. Regarding draws, the rules are whatever you have negotiated and put in place with your sales rep. Unfortunately, many people have little experience with draws and have not framed them with terms and conditions.

    Most recoverable draws do not reset. That is a condition normally associated with a non-recoverable draw. With a non-recoverable draw, you can reset after a day, a week, a month, quarter, year, whatever. It’s up to you and what makes sense for your business and your employee. You can also set your draw to recover only against commissions. Or, you can make the draw non-recoverable for a period of time and pay commissions on top of the draw. In this case, I would make the draw decreasing over time as commissions increase. It eases the pain as the sales rep establishes his territory.

    The structure of a draw is limited only by your imagination and what’s acceptable to your business and your sales rep.

  21. Obligation to repay a draw upon leaving employment depends on your state. I recommend that your brother-in-law check with his state’s department of labor. In New York, the company cannot require repayment of the draw. They may ask for repayment, but they cannot force it. Your state may be similar or may be different. Please check with the state or a local labor lawyer.

  22. In my experience, the “annuity” sales and associated commissions go with a territory. So, if a new rep takes over the territory, s/he would also assume responsibility for the annuity sales. Responsibility means you must continue to provide customer service and re-sell the customer regularly to maintain the relationship. With the responsibility should also come the commissions (and quota).

  23. A draw is not compensation for effort or time worked. It is a loan against commissions. Sales people are paid commissions (usually a percentage of revenue or gross profit) on the sales they close. Therefore, on days that you are not selling, not closing business, you are not earning money. Since the company does not pay you for anything except the sales you produce, and if you produce you should earn much more than hourly or salaried peers, the company does not owe you anything. If you want to be paid for time away from selling, you may need to negotiate that separately.

  24. A company can administer their draw according to their needs and their employees’ needs. With respect to the 4.4K (20% of the 22K) the employee owes, given his value and potential, if you hold him to paying it back, is he likely to stay or leave? Do you want to extend goodwill or an olive branch to this employee?

    You can structure your draw as fully recoverable (it’s a loan and the employee has a full obligation to repay – check with a labor lawyer in your area to determine if this conforms with local laws), recoverable against commissions (a loan that can only be repaid by earned commissions) or non-recoverable (draw provides a minimum level of income, does not have to be repaid, but commissions only kick in after an agreed-upon level of production is met). Draws can also be various combinations of the above. Draw structures are limited by your imagination and what the parties agree to.

  25. I receive a recoverable draw if my commission doesn’t hit a certain dollar amount. My question is can they tax the draw money? I understand that technically it is a “loan” but right now I am taxed on the disbursed draw funds and taxed again on the funds they recover. Is that legal? I thought that a “loan” which is repayed should not be taxed, especially since it will not be included in my W2.

  26. The IRS and most, if not all, states treat a draw as income. Therefore it is taxable and subject to withholding. However, it all comes out even when you file your tax return. If you have enough commissions to cover the draw, you will pay taxes only on the amount you earned. If you do not cover your draw with commissions, but still repay the draw, then your income will be reduced by the amount you repaid. If you earn commissions, but don’t cover the draw and you have an outstanding amount at the end of the year, then you will pay taxes on the commissions you earned plus the additional draw you received over and above the commissions. In any event, the taxman will get what you owe.

    If you have concerns about your specific situation, I recommend that you speak with an accountant or tax specialist. My comments are only a layman’s perspective based on my understanding of the law. I do not offer legal advice.

  27. hello,
    Can a non-recoverable draw, be conditioned upon the successful completion of the probationary period? In other words, if the employee does not successfully complete the probationary period, can the employer recover commission advances from the final paycheck?

    Kind regards

  28. Karen,

    The answer to your question is very much dependent on where the sales person works or lives. In some states, such as New York, the outstanding draw is not recoverable if an employee leaves the company. It is treated as regular income. In other states, the employer may be able to recoup the draw. I recommend that you get legal advice from an attorney who specializes in employment law in your local area.

    Dave

  29. Hi David,
    Do you have any resources for examples of draw against commission agreements? The internet isn’t on my side for this!
    Thanks!
    Laurie

  30. Laurie, Most draw against commission agreements are pretty simple. Often, they are only one or two lines included in an offer letter. However, I prefer to include the following in draw offerings:

  31. Draw amount and frequency – for instance, $2000 per month.
  32. Length of draw – draw will be paid for X months
  33. Maximum outstanding draw – outstanding draw will not exceed $xx,xxx.
  34. Draw recovery (repayment) terms – when does draw get repaid and how? Repaid from commissions only? Upon leaving position? Upon leaving company?
  35. i work for a car dealership i’m paid 100 per day draw based on 22 working days in a month. works out to about 2200 i get 3 weeks paid vacation and they still deduct the full draw from my commission is that legal

  36. Yes, deducting draw from your commission, even though you are on vacation is legal. A draw is not a salary. Technically, a draw is a loan from the company to you in advance of the commissions you earn. It sounds like at the car dealership you are working on 100% commission basis. On the days you take vacation, you are not selling and therefore you are not earning commissions. The draw, however, since it is a loan against future commissions, must be repaid.

  37. Hi David, I have a question- my contract reads as so:

    In consideration for the Specified Services, the Corporation will pay the Contractor an amount equal to
    fifty percent (50%) of all net advertising revenue generated by the Contractor pursuant to this Agreement (the “Commission”). The Corporation will pay the Contractor the Commission according to the following schedule:

    (a) a non-refundable payment of $3,000.00 per month (the “Draw”); and
    (b) a monthly payment if any equal to the amount of the Commission to date minus the Draws to date (the “Reconciliation”).

    To me, this reads that I get a check each month for $3,000. Then after I sell $3,000 worth of product we split the sales 50/50. So, if I sell $4,000 worth of product I am paid $3,500. Does that sound right or am I misreading?

  38. Liz,

    The contract is a bit fuzzy, but not in the area that you are unsure about. The question I would want clarified is whether the draw accumulates over time and therefore the reconciliation is applied to the total outstanding draw or does the draw reset every month (non-recoverable draw) and so you start with a zero draw balance at the start of each month. The latter is preferred.

    With respect to your question, the commission on $4,000 of sales is $2,000. The $2,000 commission is then applied against your draw. Therefore, you would not be entitled to any additional payment for the month. You’ve already been paid $3,000 in that month although you’ve generated commissions of only $2,000. Think of the draw as a loan against future commissions. To earn a reconciliation check in a month, you would need to sell more than $6,000 of advertising, assuming that your outstanding draw at the beginning of the month is zero.

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