Every organization should determine the right compensation plan for each individual sales role upfront using a proven target-setting model and a multitude of other factors. Companies should consider how to structure base and variable pay and then set forth the responsibilities of the role and the terms of compensation clearly in a sales incentive plan.
Compensation in Sales Positions
The first step in providing fair compensation to each customer-facing role in your SaaS sales organization is the analysis of the following positions, duties, and experience required by each:
- Sales Development Rep (SDR): Prospecting. Positions may range from a first SDR job (Junior) who is focused on inbound sales to a Senior SDR with one to four years of experience who calls on key accounts (Account Development Rep).
- Account Executive (AE): Sales Acquisition, also known as a Sales Manager (SM). Positions may range from a first AE job (Junior) to an AE with three to five years of experience (AE), or four to eight years of experience (Senior).
- Customer Success Manager (CSM): Focused primarily on onboarding and enabling the client to use the product to create recurring value. Often with one to three years of experience.
- Account Manager: Focused on the company’s key accounts or driving new/more revenue from existing accounts. Often a former AE with three to five years of experience.
Step 1: Basic Guidelines
As a general rule, there are some basic, practical guidelines that you should follow as you plan and negotiate compensation with your sales organization team members:
- Keep it simple. Your compensation plan should fit on a single page of paper.
- Show causality. Make compensation directly related to the desired effect you wish for the team member to achieve.
- Think short-term. Keep the time between the activity and the compensation less than 60 days.
- Make it fair for everyone. All compensation must be fair and equal for everyone.
- Make it easy. Compensation should be easy to measure and easy to administer.
Step 2: Establish Levels of Experience
Begin by establishing three levels of roles within your organization: 1) Entry Level, 2) Baseline, and 3) Experienced/Top Performer. See Table 8.1 for descriptions of important sales roles and their accompanying levels of experience. There is an organizational need for three layers of experience in order to create a difference between an entry level position on one end of the spectrum and experienced on the other. Employees want to see progress early on in their careers, and these micro promotions answer that request and allow you both to make small adjustments accordingly.
Table A. Overview of sales titles and job descriptions
Step 3: Start with On-Target Earnings
First, start with the On Target Earnings, or OTE, when determining compensation structure. OTE is the amount a person could be paid annually, and it has two elements: 1) a base salary, and 2) a sales incentive, also known as “variable” pay, which will be determined by employee performance. See Table 8.2 for a sample compensation table broken down by base salary, variable, and OTE.
Companies should refrain from calling any sales incentives a “bonus.” A bonus is not guaranteed and usually on-the-spot, whereas an incentive plan is forward-looking with payment tied to the achievement of specific objectives that have been predetermined, communicated to the employee, and noted in the incentive plan.
Table B. Overview of compensation in the Bay Area
Step 4: Determine Base vs. Variable
The goal behind the variable is to develop a performance-driven culture in which your sales team is financially accountable for its results. The ratio between the two types of pay is also referred to as “leverage.” A plan with a high variable alongside a low base salary is referred to as highly leveraged compensation plan.
A highly leveraged plan will mean that you only pay for results, however, this can create a lot of issues. For example, senior salespeople may not be interested in these positions as the banking system penalizes them when they apply for a mortgage, car loan, or any other request for credit. Highly leveraged plans are seen most frequently in transactional sales, where the volume is extremely high and prices are low. On the other hand, if the compensation plan has little leverage, your salespeople may be less motivated to deliver against set goals. See Table 8.3 for commonly used leverages and when they are used.
OTE can fluctuate per region, so it is highly recommended that you consult with a local recruiting firm to help determine your compensation structure before making an offer. See Table 8.4 for examples of OTE based on geographic region. Table 8.5 provides an overview of compensation packages for different sales roles in the Bay Area.
Several other variables will impact your company’s compensation plan as well, including your market, brand name, product, sales cycle, contract value, and go-to-market model. Table 8.6 breaks down each of these variables and how you should incorporate them into your compensation strategy.
Table C. Overview of commonly used leverages
Table D. AE salaries by region as of mid-2017
Table E. Overview of compensation packages in the Bay Area
Table F. Variables impacting compensation plans
Step 5: Target Setting
There are three models of target setting that can help you determine appropriate compensation plans, each with its own pros and cons. In this instance, consider a platform product with an Average Contract Value (ACV) of $25k:
Top-Down Target Setting: Start with the amount of revenue you wish to generate (for example, $4M in ARR). Divide this by the number of salespeople you have or wish to have (for example, 4) so you can determine how much revenue that equals per salesperson. In this case, $1M ARR per salesperson. You then divide that number by the ACV per deal ($25k), which is equivalent to 40 deals won per year (or slightly more than 3 deals per month). The problem with this older B2B approach is its lack of predictability. If something goes wrong, it will be difficult to measure where and when it occurred.
Bottom-Up Target Setting: Use 80% of your best month to date as your guideline. For example, the founder over the past year was able to close $800k in business at an ACV of $25k. When hiring a salesperson, therefore, the target will be set for $640k. To hit the same $4M target, you will need ~6 sales people. The problem with this model is that founder-based sales are not scalable, and it does not take into account support or dependencies. For instance, what if you need 4 SDRs to achieve this target but 2 CSMs to bring on the client? Your company would be operating at a loss. This is a common situation in today’s sales organization as the cost of acquiring a client has increased dramatically.
Business-Case Target Setting (Recommended): In this example, a sales acquisition team that sells a CRM platform uses one SDR ($80k), one Junior AE ($160k), and one-half a CSM ($120k divided by two) to prospect, win, and onboard 20 deals per month at $25k each. This means that it costs a total of $300k. Therefore, to make a profit, this team needs to bring in at least $300k, though it is generally recommended to bring in 2x that number, so the target should be $600k. It takes three months to ramp the team, and Year 1 and Year 2 are as follows:
- Year 1: $600k / $25k = 24 deals (take into account a 3-month ramp)
- Year 2: $900k / $30k = 30 deals
You will also want to consider the significant impact of Lifetime Value. For example, in the FedTech space, SaaS contracts can be established with three years of commitment. This allows for a richer compensation plan compared to a company with a nine-month client LTV (AdTech, for instance). When selling new products for which LTV has not yet been established, companies should not spend more than 40% of Year 1 revenues on the aggregate cost of OTE for SDR, AE, and CSM roles. For LTVs of 2+ years, companies should not spend more than 60% of Year 1 revenues.
Table G. An overview of targets by role
Step 6: Account Executive Compensation
To apply each of these compensation models when hiring a AE, consider the following assumptions:
$80,000 in variable compensation needs to bring in $900,000 across ~30 deals with an ACV of $30,000.
Junior AE Assumptions:
Linear Model: $900,000 in 30 deals vs. $80,000 in compensation = 8.8% of every sale every month. This is good for business at the speed of 2-3 deals per month using a two-stage (SDR/AE) sales organization.
Accelerated Model: This model will drive behavior to close more deals towards the end of the season with results as follows:
- 6.4% on first $500,000 ($32,000 in commission)
- 12% on $500,000 – 900,000 ($48,000 in commission)
- 15% over $900,000 (upside)
- Remember that this model also requires matching of the commission season to the buying behavior of your customer. For example, schools/districts buy from March to July, federal government from August to October, enterprise clients from November to December, and retail from March to July.
Business Model: Depending on the results that your company seeks, these sample compensation structures are effective in the following areas:
- Size of Deal – Very effective in driving a team to sell more items to increase the price: 5% on deals less than $20,000k, 10% on deals greater than $20,000, and 15% on deals over $30,000
- Market – Very effective to open up new markets: 7% to schools in California and 10% to schools in Colorado
- Product – Very effective to drive sales of new products: 5% on standard platform, 8% on add-on services, and 15% on new platform services
Table H. Example compensation plan for an AE
Table I. Example payout of AE using Accelerated Model and Business Model
Step 7: Compensation During Onboarding/Training
For professionals who already earn $10,000 a month in commission, it might be difficult to digest the idea of foregoing that type of money for three months when they first start working at your company and require training or onboarding. As such, it is normal for these candidates to ask that you pay this amount during the training or onboarding period. To facilitate this process, you will typically use what is known as a “draw.”
Using the example above, consider a salesperson doing $80,000 of business per month. Divided by 12 months, that equals $6,667/month. Compensation options might include the following types of draws:
Draw: Commission paid upfront against the promise of performance. Think of this as a loan without interest.
Non-Recoverable Draw: You pay $6.67k per month. If they close $10,000 worth of commission, you pay $3,333 extra. See Table 8.11 for ideas on how to make new hires “earn” the non-recoverable draw.
Recoverable Draw: You pay $6,667 per month upfront. If they only close $5,000 worth of commission, the amount of $1,667 rolls over to the next month. See Table 8.10 for more examples of recoverable versus non-recoverable draws.
Clawback: In the above example, the salesperson would have to pay back the company $1,667. Clawbacks can be used against draws but also against deals on which commission was paid if the client churned following less than three months of use. (This is often the result of selling to the wrong customer.) It is not common to claw back commission if the client churns after more than 3 months of use. (By this point, it is deemed the responsibility of the CSM team.)
Bookings vs. Cash Collections: This is a touchy subject as business in most rapid growth companies is risky. A booked client does not guarantee cash collection. Consider the following baseline ideas when deciding whether to structure compensation against bookings or cash collection:
- Compensation against bookings accelerates deals and is best used during growth. Compensation on cash collections improves the quality of deals and is commonly used during maturity.
- Early stage companies do not want to hand out money, but compensating on cash payments will not make this easier. In particular, it may result in the following downsides:
- Delayed incentives result in lack of causality
- Difficulty motivating a team on cash goals ~45 days after the deal closed
- It may signal to top talent to ignore your company as something must be wrong (high churn rates, etc.)
- There are easier ways to ensure that you only pay against companies/deals that paid:
- Claw back the next month any deals that fell through the previous month.
- Adjust quota to accommodate for premature churn.
Onboarding/Training: For companies with a sales cycle up to 90 days, 90 days is the most common onboarding time. If you sell a complex security solution and you have no prior experience, however, onboarding can easily take six to nine months. On the other end, if you are selling a Google plug-in, you may only need a few days to onboard.
As an example of a draw, consider a linear model for a compensation plan of 10% of sales based on a $900,000 revenue target with a 90-day ramp versus a variable compensation of $90,000/year or $6,667 per month.
Table J. Impact of recoverable vs. non-recoverable draw
*If it does not exceed the guaranteed draw ($2,500), the draw prevails and it rolls into month 4.
**In sales speak, this is often referred to using the bowling term “the bumpers are coming off.”
***Any sales professional in a startup role will request a non-recoverable draw. This is valid because they are not aware of the risks they face, and in a hyper growth new role, there is plenty of risk. Compare this to a more traditional sales role in which the person takes over an existing/developed territory that brings in 80% of goal due to brand name recognition.
Table K. 90-day onboarding program to make new employees “earn” the non-recoverable draw
Step 8: Sales Development Rep Compensation
To apply each of these compensation models when hiring a SDR, consider the following assumptions:
$40,000 in variable compensation needs to bring in enough deals to win 30 deals per year.
deals with an ACV of $30,000
Linear Model: In this case, the SDR is closing 30 deals per year with a 1:5 win rate (this is the norm in SaaS sales vs. 1:3 in perpetual sales) which equates to 150 leads per year. $40,000 divided by those 150 leads equals $267/SQL, or rather $250/SQL. As the SDR generates 12 SQLs per month, that will equal $3,000 in commission. This also means that for every deal won at an ACV of ~$30,000 at a 1:5 win ratio, you will have to pay for 5 SQLs, which will cost your company $1,250.
In comparison, it is common to pay an external firm $500 for every meeting generated and $1,000 for every meeting set with a decision-maker. A referral fee of 5% ($1,500) is also common for an introduction at the manager/VP level or 10% ($3,000) at the CxO/Board level.
Accelerated Model: You can use this model to drive behavior toward qualifying the right deals. Plan to spend $1,250 for 5 SQLs since this is what the business model states above, but pay less per SQL. For example, $150 instead of $250 each. That means you will pay $750 total for 5 SQLs @ $150 each, which leaves you with $500 remaining, so you can now pay out $500 for every deal closed. In this case, you end up paying the same amount but drive behavior to identify quality SQLs.
Business Model: To drive behavior toward the opening of a new market, offer $150 for a medical company but $250 for a financial institution. To drive your team to reach seniority, offer $100 for a meeting with a manager and $150 for a meeting with a CxO/VP title.
Importantly, the definition of SQL and SAL needs to be clearly defined in either the compensation plan or printed on a poster on the wall of your company where it is clearly visible for all team members to see. Be sure to give examples to your team of what constitutes an SQL, but also remember to give them examples of what does not constitute an SQL.
Table L. Example compensation plan for SDR
*A junior SDR is often the same as a Marketing Development Rep calling on inbound leads only, whereas the senior SDR is often the same as an Account Development Rep calling on fewer targeted accounts along an ABM campaign.
Table M. Example compensation payout for SDR
Split Model: The SDR role is often under pressure because their compensation plans are held accountable against market metrics that frequently reset themselves. Whereas a few years ago, generating 30 to 40 SQLs per SDR per month was quite feasible, today the figures are closer to 10 to 15 SQLs per SDR per month, though this fluctuates with different markets, regions, etc. Due to the lower SQL count, you may follow the model and conclude that you need to compensate your SDR $500 or even $1,000 per SQL, however, such a high value per SQL invites the SDR to take advantage of the model. In such cases, you should split the model by reducing the price per SQL to $200-250, and then adding compensation for productivity in the form of number of emails, calls, event sign-ups, visits to trade show booths, etc.
Table N. Metrics to consider in SDR compensation plan
Quality vs. Quantity: To generate volume, you can compensate based on SQLs for meetings set. This, however, may lead to an influx of unqualified deals. To set a standard for performance, the AE can accept the lead, turning it into a Sales Accepted Lead (SAL), which offers you three options to guarantee quality:
- Compensate on SQLs, but lower the price per SQL from $100 to $50. Note that you are wasting AE resources if they have a lot of unqualified calls.
- Compensate on SALs instead of SQLs. This reduces the velocity, but creates a strenuous relationship between the SDR and AE, as the AE may disqualify deals that SDR worked hard on.
- Add a Quality Measure. Shift the gravity of the compensation within the compensation plan. For instance, $50 per SQL + $500 per deal won.
- Claw back commission at the end of the month by taking out all deals that did not turn into an opportunity.
Account Development Rep Compensation
Account Development Reps (ADR) are different from SDRs in that ADRs focus on key accounts or targeted accounts. They are often responsible for implementing Account-Based Marketing (ABM) campaigns as well. The compensation of an ADR is different because it is focused on a fraction of the accounts. This role has three key elements – Activities, Engagement, and Impact – which can be distinguished from the roles of an SDR, as displayed in Table 8.15.
If you have a group of Development Reps, you may have to combine a variety of these tasks across roles and across time. For example, a major annual event such as an industry trade show may influence the way you compensate each role.
Table O. Differences between SDR (outbound) and ADR (targeted accounts) compensation plan
Typically, a rapidly growing firm will compensate SDRs as follows:
- Outbound Target: By Sales Accepted Leads (SAL) created by outbound campaigns (1 to a few). Generation of these SALs are based on call volume MBO (management by objectives).
- Account-Based Marketing Target: By Sales Accepted Opportunities (SAO) created by ABM campaigns (targeted accounts). SAOs are tied to setting up calls/meetings with people within these accounts.
- Event Target: By meetings set at events. For example, for large events such as Dreamforce, a quota is added for meetings, e.g. “Book 10 meetings a day at Dreamforce.
Table P. Example Compensation Plan for ADR
Step 9: Items to Include in Sales Incentive Plan
The Sales Incentive Plan that you agree to with your employee should include or specify all of the following terms, tailored appropriately to your business needs:
Monthly vs. Quarterly Payments: Evidence clearly shows that monthly payments reduce “the hockey stick effect” or the scenario in which 50% of all sales come in the last two weeks of the quarter. There are very few exceptions to this rule.
Payment: With 50% of compensation based on commission, you must pay compensation on time with the same due diligence as any other salary compensation. The industry norm is one payment cycle after the quarter closes (e.g. within 30 days of the month’s close).
Capping: If capped at $400,000 annually, this means that even if total compensation exceeds $400,000, the team member will not get paid above $400,000. This is a common practice for companies in which strategic deals have a large team working on them. For example, a Fortune 500 company may choose to deploy an enterprise-wide solution following a series of meetings at your CEO/VP’s office that the AE was not part of. In this case, the AE should be notified that capping may apply.
Override: To overcome unknown scenarios, all compensation plans should contain an override by the CxO/VP. For example, if a sales team falls $400k short on quota, the CEO may work with a board member to have a portfolio company “buy” the product/solution in order to overcome the shortfall. This is a situation in which the override authority might be enforced.
Fair Compensation: Sales has been an alpha-centric job for decades, therefore, sales compensation receives a lot of scrutiny with regards to equality in gender, age, race, etc. At the same time, it is common practice for a VP of sales to bring in a former sales performer or individual contributor at an increased pay rate since they are a known entity. As another performer is let go to make room for the “top performer” (or due to his or her underperformance), there may be grounds for a lawsuit. Regardless of the performance of the former contributor, if he or she was not fairly compensated during his/her tenure, there will likely be grounds for a lawsuit.
Fair Compensation Board: It is strongly recommended that portfolio companies with more than 25 people establish a Fair Compensation Board which contains the CEO, an internal executive, an industry expert (often a board member), and an external HR professional who agree to quarterly review compensation and ensure fairness. This not only protects against hiring people at overly large compensation rates, it also allows underrated top performers to get noticed and put on an accelerated career path.
Step 10: Draft a Two-Page Contract with Mutual Commitment
The following page contains a sample Sales Incentive Plan that may be used as a template with new hires:
Sales Incentive Plan
Revision Date: June 23, 2017
This document describes the agreement between ______________ (“Company”) and ______________ (“Payee”) regarding terms related to sales incentive compensation. Company and Payee enter into this agreement whereby Payee provides services to the Company in return for compensation specified in this agreement.
Table 1. Overview of the Payee Compensation Plan
All commissions will be calculated and paid once every month, for the preceding month. Commissions will be calculated and paid out as part of the next payroll cycle, following the month for which commissions are calculated.
Base Salary Payout – Sales Rep is due a base salary of __________, payable every __________.
Sales Incentive Payout – Sales incentive compensation is payable every __________.
Expenses – The Account Executive will be paid for all travel and lodging expenses related to sales activities within 30 days of being presented with the receipts and a completed and accepted expense reimbursement form.
Travel and Lodging:
Auto Travel Reimbursed at the current federal reimbursement rate
Cell Phone Sales Reps will be required to maintain a cell phone as part of conducting sales business. Sales Rep will be provided an allowance of $50 per month for cell phone usage.
Client entertainment expenses will be reimbursed as follows:
Meals/Coffee Reimbursable with receipts
Special Events Must be pre-approved. Reimbursable with receipts
Draw – Payee receives a monthly non-recoverable draw against the sales incentive plan as follows based on the participation and completion of the 90-Day Onboarding Program.
Table 2. Eligible Draw Month-over-Month
Clawback – In order to receive your full commission with no clawback, the customer must stay live for 3 months from the day we start billing the customer. If a customer cancels short of the 3-month mark you will have a prorated amount clawed back from your commission against the sales made.
Draw Clawback – If Payee voluntarily leaves the position within the first 6 months of this plan, the Draw payment(s) will be due back to the Company through a payroll deduction from any monies owed to Payee.
Splits – Commissions can be split with other Payees, on a deal-by-deal basis at the discretion of the VP of Sales.
Termination of Employment – On voluntary or involuntary termination of Payee’s employment with the Company, commissions will be paid on transactions dated prior to the termination date only. Any amounts owed to the Payee will be according to employment regulations after withholding taxes and other dues.
90-Day Onboarding Program – The onboarding program will take place over 90 days and the following activities are expected from the Payee to be eligible for the Draw as outlined in Table 2.
Table 3. 90-Day Onboarding Program
Other Important Terms
- Payee agrees to follow all federal and local laws while engaged in providing services to the Company during the period of this agreement.
- Payee shall not engage in any other employment during the term of this agreement. Company reserves the right to require Payee to terminate any such other employment at Company’s sole discretion.
- Payee shall use the most ethical practices while engaging in any sales activity.
- Payee agrees to protect all confidential material including prospect data, sales data, and client information belonging to the Company and shall take all reasonable care in making sure that such confidential material is not disbursed to anyone outside the company.
- This entire agreement shall be governed by the laws of the State of _______________.
- VP of Sales reserves the right to override the terms of this agreement without cause.
Company / VP of Sales
Payee / Sales Rep