Unlock the potential of your startup’s sales team with effective sales compensation plans. In this comprehensive guide, discover the 5 golden rules that startup founders need to know to create winning sales compensation strategies.
Coin Operated Professionals
Sales incentive plans are really delicate things. This stems from the fact that the best sales professionals are “coin operated”. It means they intuitively do whatever puts the most money in their pocket, within legal and ethical boundaries. They do so assuming the company has put a lot of thought into how they are incentivized. Therefore, whatever pays them the most surely is good for the company too. Because of this, don’t expect a sales rep to read your mind.
Never break these rules when setting commission plans for your sales team.
Business Strategy Alignment
Make sure the compensation plan drives behavior that is consistent with your business strategy.
Charlie Munger, longtime vice chairman of Berkshire Hathaway, once said “Show me the incentive and I will show you the outcome”. Remember that the best sales professionals do whatever puts the most money in their pocket. That means it’s your duty to make sure your business strategy drives their actions.
Below are some examples of business strategies and corresponding sales compensation strategies to consider:
- Aggressive land grab of new customers – compensation tied to quantity of new customers acquired
- Revenue growth target – compensation tied to revenue amounts achieved
- Long-term revenue predictability – compensation tied to multi-year contract value
- Success of newly launched product is critical – bonus compensation tied to the sale of the new product
This requires some advanced thinking and scenario planning to identify loosely defined rules or “gray areas” that can be exploited to boost compensation. To best get inside the mind of a money-hungry sales rep that is looking for loopholes, you MUST read my related article titled “Is Your Sales Incentive Plan Driving Bad Behavior?”.
Never Change the Rules in the Middle of the Game
Before officially announcing the plan details, try to identify accidental loopholes or opportunities for bad behavior that maximizes earnings. Then, stress-test your compensation plan by modeling various simulated results. I’m talking about results simulate a sales rep far exceeding their targets.
If You Discover a Mistake
Most compensation plans are established for a year at a time. If you discover a big mistake and absolutely have no choice but to make a change mid-cycle, come clean with your sales team. Explain the mistake and the rationale for the needed change. Also think about how to handle in-flight sales opportunities that are about to close. Some might have paid more sales commission before the change. Some concessions and “grandfathering” might be appropriate. Remember, it was your mistake that caused the whiplash. The sales professional was trying to earn the most commission possible using your rules.
If your exposure isn’t significant, you might be better off looking the other way and “biting your lip” until you approach your next plan cycle. Then you can modify the commission plan. In other words, think about the risk-reward trade-off. Understand that changing the rules in the middle of the game might cause you to lose some of your best sales reps. But even in that case, you might want to let your sales team know you realize a mistake was made and that you’re going to stick with the plan through the end of the period. That way, they understand things won’t be that way for the next period.
Start with a Shorter Plan Period
In the very early days after hiring your first one or two sales reps, you might not even know what makes for a reasonable quota or target. In that case, don’t lock things in for a full year. That would leave you with too much risk of being way off, either on the high side or low side. Neither is good. Instead, set quotas for only a few months or 1-2 quarters at a time. Soon, you gain the needed insights, maturity and wisdom. This approach will minimize the need to change quotas or other elements of the commission plan in the middle of the cycle.
Keep it Simple
If the plan requires the sales reps to have a magic decoder ring to figure out if/when/how they will get compensated, you’re in trouble. Minimize the number of metrics the sales team gets paid on. Prioritize what’s really important to business strategy alignment. Also use simple language to communicate the plan.
If you have a sales rep you can really trust, get their opinion ahead of time. Ask them if the plan is simple to understand. After they read the draft plan, have them explain back to you how they will get paid. Then ask them how they would go about maximizing their earnings on the plan.
If you absolutely don’t want to get feedback on the plan ahead of time, do it immediately after announcing it to the team. If you have a sales manager that manages the sales team, they can be an ideal proxy for pre-review.
Be Very Clear
This can sometimes be at odds with keeping things simple. But it’s important to minimize accidental misunderstandings. One way to do this is to include some definitions and examples in the official documented compensation plan. If you don’t have such a document, read my related article titled “Documenting Your Sales Compensation Plan” and use my template.
Below is a list of just a handful of examples of metrics or terms that should be clearly defined. Basically, if there’s any possibility of misunderstanding what a metric or term means, define it and consider giving an example.
- MRR or ARR
- Contract value
- New customer or new account
- Contract term
- Profit or profitability
This is especially true if timing requirements are involved. For example, no commission payment is earned until the customer pays their invoice. Another could relate to any condition that would reverse a previously paid commission (called a “clawback”).
If after announcing the plan, you quickly discover misunderstandings or different interpretations, you have a very short window in which you can add clarification. Clarification is different from changing the rules, especially if done very early in the sales plan period.
Avoid Earning Caps
You might conclude that it’s extremely unlikely that a sales rep could make $500K or more using your commission plan. But if they did the things necessary to achieve that, would it harm the business to pay it? I know you’d rather not pay it if you don’t have to. But the question is would it harm the business? If you followed golden rule #1 (business strategy alignment), this hopefully will not be an issue.
Celebrate High Earners
In most cases when this happens, it means the sales rep sold a ton of stuff that brought a ton of revenue and profit to the company. Congrats! Successful companies with more than 10 field sales reps will often pay the highest performer more than the CEO over the course of the year. Such a rep often achieves 200% or more of their quota.
This is hopefully something to celebrate. It can also be used to energize the rest of the sales team and to attract additional high-achieving sales reps into the company. The top handful of sales reps at Fortune 500 software companies often make $1.5M or more.
The only exception to this rule comes in the very early days with your first sales employees and very limited maturity in setting quotas. If during this period you might decide to implement some sort of cap to commission earnings potential. If so, have a discussion with the sales team to make sure they understand why it’s in place. Also let them know you plan to remove the cap as soon as the company is more mature with measurements and forecasting capabilities.
An alternative to setting a hard cap is to message that “management judgment” may be imposed for commission calculations that exceed a certain amount. With this, don’t get greedy with the number. Instead, let the sales reps see their way to very nice earnings if they greatly exceed their target. Only act on the judgment if great unfairness or harm to the company results.
Effective sales compensation plans will absolutely make or break the effectiveness of your sales function. Whether you’re an experienced sales executive or have never made a professional sales call in your life, following these golden rules should serve you well.