Sales commissions

What's your experience in offering sales commissions for long-term recurring revenues?

Yaya Mbaoua

June 4th, 2014

Hi folks,

My friend is willing to bring in clients for my startup as a sales consultant. I am unable to pay him any salary but offered to pay him a commission of x% of revenue generated from his clients. 

Clients will typically sign a multi-year contract. I am wondering if the commission payment should be limited to the 1st year of the contract or the full term of the contract. 

What has been your experience in setting this up? I want to be fair and more importantly, I want to keep my friend.

Thanks!

EM

June 4th, 2014

@Yaya -- it variously enormously by industry. Ad rep firms will take anywhere from 25-60% of ad revenue from a small publisher (in essence, that's what Google does for all the media they sell on other publishers' properties). On big ERP deployments, referrer sales reps may just take a few points. 

What drives down the commission:
a) the margin in the industry
b) how much marketing you are doing to build awareness?
c) whether you are handing off warm leads to the sales rep
d) what sales support you provide
e) deal value
f) time/effort to close
g) how difficult it is to access/close those clients
h) what resources your friend needs to invest to close

If your friend doesn't have some secret sauce, industry experience, amazing network (i.e. some form of unfair advantage) then it doesn't really matter that they are your friend; their cost of closing deals will be higher than a specialist who knows the business well. If your friend has an unfair advantage then you should jump on them and lock up their commitment. 

While declining payouts might look nice, there are lots of downsides for both parties that you need to consider:
a) there's real maintenance cost involved to paying reps over the long-term
b) most deals start small and grow over time and that increased value is usually attributable to account management (+ evolving product) over sales -- you will pay too much if they get a cut of everything from the account
c) it can get real contentious on high-value accounts
d) at the start, just having customers matters most so someone needs to get customers....
e) most sales reps optimize for cash-in-hand vs residuals (especially when dealing with startups) 

At this early stage, get the deal done with your friend at a mutually agreeable price that doesn't come with long-term maintenance. Depending on time to close accounts, you'll know the unit economics after X  months and you should write into the agreement a review process at X months to reevaluate the relationship (and pricing). 

Eric Bernal Co-Founder, Director of Web Development & Design

June 4th, 2014

I think it varies widely from industry to industry and you have to consider various factors.  For example: value of the contract, length of the sales cycle, etc.  When my partners and I built up mywedding.com, we found that allowing sales people to earn their full commission on every yearly renewal really helped to fuel our growth. Our sales people were well compensated, but in return our expectations were also very high. Our compensation packages also attracted a lot of great talent.  You get what you pay for. If you try and nickel and dime your sales people and if you keep changing the commission structure on them, you will lose out in the long run.  Our most lasting and fulfilling achievements are often earned by helping others fulfill theirs. You will succeed when you help others around you succeed as well!

Rob G

June 4th, 2014

Yaya;

designing a good sales compensation plan is not easy - that's an understatement, and you will be served well by spending time up front to cover all the possible details.   understand that a well designed sales comp plan incentivizes good sales habits and discourages or at least does not reward bad practices.  Understand that you want sales people who are money motivated (good) and if the comp plan is designed correctly they will run through brick walls to hit and exceed those goals (also good), but be careful not to incentivize bad habits or 'gaming the system' (bad).  Money is a strong motivator and you don't want your sales people running contrary to the company's best interests in pursuit of their personal financial goals.  Think through every possible sales situation and how that will affect the sales comp plan.   As a random example, your guy goes and sells a deal to a F-1000 company.  next year that company acquires another company and needs more of the same widgets/services that s/he sold the parent company.  Do you pay the same commission rate for what was essentially no effort on his/her part?  If you think that sort of situation won't come up think again.  i would strongly suggest you include a clause in your plan that gives you/the company the final say in how any particular sale is compensated.  Outline the possible scenario's you can both think of and how that will be compensated and then add a claus that gives the company flexibility to handle the exceptions.  Commission rates vary widely by industry (in only have experience in software and tech/engineering services fields) but as Scott mention, you should start with a target for total compensation and work the commission rate backward from there.  Total comp also varies based on the type and size of customers/accounts, competition, length of sales cycle, etc.  understand that, in this case with out a base salary, you are asking your sales people to take on additional risk (i.e. if i sell something can the company deliver?) and higher risk = higher reward. Selling products/services for early-stage companies is typically more difficult than it is for mature companies with a track record and market acceptance.  Factor in lack of marketing/lead-generation/pre-sales and post-sales support for the typical early-stage company and you can expect that you will have to offer significantly higher commission rates than for a comparable mature company. Also, as it relates to how long to pay commissions: again, without knowing what industry you are in it is hard to say, but in my experience there are two kinds of sales people and there is typically room for both in company:  hunters and farmers (cliche i know).  most early-stage businesses go through cycles of feast and famine.  design your sales comp plan to drive for steady and rapid growth, but not too rapid.  say your sales person goes out and closes a big deal as you want him/her to.  Then the company needs to perform and deliver for that customer.  If your sales comp plan, for example, compensates this sales person the same rate for selling additional products/services to existing customers as it does for closing new customers then often the path of least resistance for the sales person is to focus their efforts on this one customer which can leave the company vulnerable.  In most industries you want to keep growing a stream of new customers which means you need to design a comp plan that incentivizes this behavior - ""hunting"  for new customers.  This often means that as soon as you can you should hire another sales person - a farmer, to cultivate additional revenue from the existing client base. Farmers and hunters are different personalities (one not necessarily better than the other, just different) so recognize this and design sales comp accordingly for both types.  I can tell you all kinds of story's about sales people making north of $500k/yr for not doing the job they were hired for - their employers designed bad comp plans.  That's along way of saying i, personally for my industry (SaaS) would not base sales commission off of gross revenue, but net profit instead (this aligns the sales people's incentives with the company's) and i would look for a way to incentivize my hunters to close high margin, high quality deals and go look for the next new client while also making sure that they have some vested interest in seeing that the company can meet or exceed the customer's expectation that s/he set during the sales cycle and perhaps some incentive to help the farmers drive additional business.  Looking at your FD profile i get the impression you are in the tech space.  I suspect your sales comp will need to be north of $200k @ target and with risk factored in and depending on your product/service pricing, you will be looking at commission rates north of 20%-30%.  good luck. 

Rob G

June 4th, 2014

Hopefully it goes without saying, but i'll say it just in case, that the whole premise of having a direct sales force (even a force of 1) assumes that your product/service is priced such that you can cost justify the expense.  I've not done the math to look for the inflection point of no return, but it's safe to assume that if a "typical sale" will have a current-money valuation (current value of the cash stream) of say, $10,000 or less and you are selling a tech product (a Saas product lets say) which means you need a more than reasonably tech literate sales person which, depending on your location/market means they are  used to making $200k+/yr for argument's sake.  Let's assume your gross margins are really fat - essentially 100% (your SaaS product has no COGS - perfect world) and lets assume that either you will get paid separately for implementation / consulting services or there is no hand-holding required because your product is so beautifully built that any yoyo can implement it (perfect world).  This means your sales person needs to make 60-80 sales/yr. - 20 sales x 3 to 4 at a minimum assuming you will pay 25-33% commissions. That's 5-7 $10k sales /mo => 1-2/wk. Is this realistic?  What sort of ramp-up time does this take?  what sort of supporting infrastructure (marketing, lean gen, advertising, T&E, etc. does this require?  those are some bold assumptions and YMMV.   the moral of the story is your price / typical-deal structure has to support a direct sales force or you need to look to plan B.  "inside" sales people are typically less expensive (can be farmers or hunters), but you can expect less strategic capabilities.  Does your product/service really need a strategic sales person (of the $200k+/yr type)?  can you sell entirely over the phone? These are just a few of the things you need to think through before designing your sales comp plan. You don't want to set your friend and your company up for failure.  my $0.0002 worth. 

Eric Landeen Director at doxo

June 4th, 2014

When I have managed salespeople, I have paid commissions based on 12 month guaranteed revenue with a 6 month chargeback threshold. So for example, if a salesperson secured a contract with a customer agreeing to pay a minimum of $1500 per month, I would pay commissions on $18K. If the customer churned away in the first 6 months, I would take back the commission by netting it against the next commission payment. This works well when you want to incent the salesperson to maximize a guaranteed minimum monthly contract amount, and you want the salesperson to care about the customer staying in the band through implementation and beyond. In my case, I've normally separated the hunting and farming functions, so there is a transition from the salesperson to an account manager and there needs to be continuity. But you don't want to incent the salesperson to take care of the account forever, you want him/her to go hunt for the next customer.

Scott Milburn Entrepreneurial Senior Executive and Attorney

June 4th, 2014

I agree with Lawrence that the commission should decline over the first three years of the contract. The commission level depends on the industry - I've seen up to 15%/10%/5% for the three years.

Rick Nguyen Cofounder @ Spot Trender

June 4th, 2014

I agree with Erick Landeen regarding separating hunting and farming. Top sales people are generally hunters, they should be incentivized to bring in as many deals as possible. Managing relationship does take a lot of time and focus off hunting, so founders should be directly involved with managing relationship, and ideally have a dedicated relationship manager. This way, when your top sales person move to another company (they tend to move often), you'll still have the relationship and the revenue from your accounts.

Yaya Mbaoua

June 4th, 2014

Thanks everyone! Really insightful and valuable advice. Truly appreciate it!

Yaya Mbaoua

June 4th, 2014

@Eric: I completely agree with your statement.

@Ramesh: I like the idea of keeping things simple

@Eoin: you're making really good points about account maintenance. I get the potential contention with this model. do you think that the sales rep will benefit from the deal size over time if he also manages the accounts? In essence he will be entitled to increased commissions because he will be responsible for growing the deals. Not?  

Yaya Mbaoua

June 4th, 2014

Scott - I like the tiered model in commissions over time (similar to Lawrence's answer above) but what justifies double-digit commissions in your industry?