Commission policies and plan agreements work together to form the concrete foundation for a sales team that is both motivated and rewarded for their hard work. Although both terms are often used interchangeably, there are some subtle differences between them.
- A sales commission policy is a document that outlines the rules and guidelines for how commissions are determined and paid to the sales team (e.g., when commissions are earned, how they are calculated, and any other conditions or restrictions that apply.)
- A sales commission agreement is a legal contract between the company and individual that outlines their specific commission plan (e.g., terms of payment, commission rates, quotas, etc.) — it’s proof that both parties have agreed to the terms of incentive compensation.
So while a sales commission policy sets out general guidelines for how commissions are determined and paid within an organization, a sales commission agreement is a contract between employer and employee that outlines their individual commission plan.
What do these typically look like in the sales commission plan? Let’s dig into more details.
What is a sales commission policy?
A sales commission policy is an internal company document outlining how commissions are determined and distributed to salespeople. It should define specific rules and guidelines like eligibility criteria, payout terms, payment timelines, etc. By establishing this policy, you can keep your sales team informed of your expectations and what they can expect in return — thus, this document should be consistent and clear so that everyone involved in the process understands it.
A commission policy for sales employees is often contained within a sales commission plan. However, the commission plan broadly outlines the overall commission structure.
Why is a policy on sales commission an essential component of any commission plan? We can best answer this question by describing the practices that will help you build an effective sales commission plan.
Sales commission policy best practices
We now know what a sales commission policy is, but what are the guiding principles when creating one?
- Transparency: To motivate salespeople to do their jobs effectively, make the commission policy specific, clear, and transparent, so it’s understandable and there’s no room for interpretation. Don't create a policy with confusing payout calculations. Clear, specific, and comprehensive conditions in sales commission policies help align a company and its salespeople on commission terms, reducing the likelihood of disputes between them over commission payout amounts. And if a commission-related dispute does arise, having a written sales commission policy in place which addresses the underlying issue can help save a company time and headache.
- Motivation: It gives employees a tangible incentive to achieve targets and drive higher performance.
- Comprehension: Don’t be afraid to include lots of examples. Many reps aren’t going to read a 10-page commission policy document in its entirety. Give them examples so they can wrap their heads around commission rates and calculations. At the end of the day, it’s about making sure employees know the expectations and desired outcomes.
- Alignment: When you ensure employees are aligned with the incentives and goals, they will be more likely to focus on the right things. Make sure the commission policy itself rewards behaviors that help achieve business objectives.
What is a sales commission agreement?
A sales commission agreement is a contract between an employee and employer detailing the commission structure and plan. In other words, it should specify how an employee’s commissions will be calculated and paid based on their performance and any other associated conditions. This commission agreement is signed by both parties — and often, it’ll include clauses for dispute resolution should any issues under the agreement arise.
To be considered a legally enforceable contract, a sales commission agreement will typically need to include these five key contract elements:
- Offer & Acceptance: An offer detailing the terms of the agreement must be extended. Think of the offer as an expression of willingness by the party making the offer to enter into a contract, where the offer can be accepted or rejected by the other party. For acceptance to occur, the other party must agree to all terms of the offer, and one way to indicate acceptance is through signing a contract.
- Mutual Assent: A “meeting of the minds” must occur between the parties regarding the agreement, meaning that the parties understand and agree to the terms and basic substance of the contract.
- Consideration: Something of value must be mutually exchanged between the parties involved, so each party must give something of value and receive something of value.
- Capacity & Competency: The parties involved must be of sound mind and have the legal capacity to enter into a contract.
- Legality: The contract must be formed for a legal purpose and must not violate any applicable laws or regulations.
Sample sales commission plan terms
This list is not comprehensive. It is just a sample of terms to consider including in a simple sales commission agreement. When you are ready to draft your sales commission agreement (or employer-employee sales commission agreement, as it’s sometimes called), consult legal counsel to help ensure all bases are covered!
When it comes to sales commission plans, the devil is in the details. This is especially true for account executive roles, which are high-stakes and highly rewarding positions.
The T&Cs in an AE’s commission plan will usually be more substantial than others due to the material risk associated with the position: an AE’s performance is typically measured through the revenue or sales volume of deals closed. The higher the deal amount, the higher the stakes. These potentially huge commissions can be extremely lucrative if they land a sale.
“Depending on the role, commission plans will look different. You need to balance how much detail you include with the material risks involved in the plan.” — Christian Borrelli, VP of Sales, CaptivateIQ
A more detailed sales commission plan might include the following policies/terms.
The “Key Summary” is typically the first section of the commission plan. It helps the employee understand the basics of the plan and may include information such as:
- Employee Name
- Job Title
- Plan Start Date
- Target Annual Variable
- Annual Quota
- Base Rate
- Accelerated Rate
Defined terms are important in legal documents to help ensure clear alignment on what each term means. Therefore, commission plans typically include a set of definitions that are relevant to the organization. Some of these terms might be industry specific — for example, OTE, sales quota, etc. — while others might be company-specific definitions (e.g., qualifying deal).
Commission Plan Overview
The “Commission Plan Overview” typically outlines the general commission structure and helps to ensure that all parties understand what they are entitled to. It provides salespeople with a summary of main plan components and potential risks associated with commission payments so that they can plan their time more effectively.
Quotas (or Targets) & Quota Schedule
“Quotas,” or “Targets,” outline the minimum sales targets a salesperson must meet to receive a commission, and a salesperson can receive a commission (or reward) if they achieve their quota within a given period, which is determined by a “Quota Schedule.” This section should spell out how quotas work and are structured, how quota attainment is measured, and the timeframe within which these goals should be attained. A quota schedule should typically include metrics such as quota type (monthly, quarterly or annual), target quota amount, and other relevant figures.
Here’s an example of what a quota schedule might look like for a quarterly quota:
- Jan-Mar 2023: $50,000
- Apr-Jun 2023: $50,000
- Jul-Sep 2023: $50,000
- Oct-Dec 2023: $50,000
“Deal Eligibility” details the criteria/conditions that must be met for a sale to be considered a deal for which a sales rep can receive their commission. This section usually covers what revenue amount commissions will be calculated on.
“Having a deal eligibility policy ensures that only qualified deals are eligible for commission payments. It also protects the company by helping to ensure that no commission is paid for any deal that does not meet its standards or could put it at risk, reducing the likelihood that the employer is exposed to loopholes or edge cases.” — Christian B.
“Ramp Period” is a designated amount of time, usually at the start of a sales rep’s employment, during which the rep typically has quotas that are less than their full quota but which increase over the course of the ramp period until the sales rep is at their full quota. For example, a company with a monthly quota and a 3-month ramp period might set a new sales rep’s quota at ⅓ of the full monthly quota for their first month, ⅔ of the full monthly quota for their second month, and the full monthly quota for their third month. This section typically specifies the duration of the ramp period and any special conditions that apply during this period.
A draw usually refers to a fixed commission advance that allows reps to receive part of their expected commission upfront. A draw is typically advanced against future, unearned commissions. Draws are often used to help reps receive income more evenly and can sometimes assist reps in bridging cash flow gaps that may occur between sales cycles.
A draw may be recoverable or non-recoverable. If a company provides a recoverable draw to a rep for a given sales cycle, then if the rep’s commission earnings for the sales cycle end up being less than the draw amount, the company can typically recoup the difference — often from the rep’s future commissions. On the other hand, if a company provides a non-recoverable draw to a rep for a given sales cycle, then the company typically cannot recover any portion of it, even if the rep’s commission earnings for the sales cycle end up being less than the draw amount — the rep simply keeps the entire draw payment.
Commission Rates and Calculations
“Commission Rates and Calculations” outlines how the commission amount is calculated. In this section, you might find examples illustrating how different commission rates apply.
Commissions Payment Schedules
This section describes the timing for when commissions are earned and paid (which may vary by deal type).
Additional Commission Terms
Some plans include additional commission terms to allow for further customization to meet each company’s needs and unique circumstances.
This section might include provisions such as:
- Time Not Worked/Leaves of Absence
- Termination of Employment
- Taxes and Withholding
- Business Ethics
- Dispute Resolution
- Employment at Will
“It is best practice for a rep to have a material impact on the deal in order to get paid. What if a rep is on vacation and is assigned an inbound account that ends up purchasing while they are out? Companies should clearly outline their policies for these types of scenarios.” — Christian B.
Build high-ROI sales commission plans
Your sales team will only be as good as the sales commission plan you create.
If you take anything away from this article, it should be to build commission plans and policies that are clear, specific, and transparent. The key to succeeding in creating a sales-focused culture is alignment.
“Tight alignment ensures all parties are clear about the expectations and desired outcomes. This means everyone understands what activities will be rewarded and how those rewards will be distributed. When there is no ambiguity, salespeople can stay focused and motivated to achieve. A well-designed commission plan fosters performance and accountability.” — Christian B.
CaptivateIQ allows you to design any commission plan without being limited by pre-set templates, save time in payout processing, and motivate sales reps through real-time visibility. Learn how JMAC Lending manages compensation in CaptivateIQ to avoid “changing [its]plans simply to conform to the system.” Read the case study!
Note: This content is for informational purposes only and should not be construed as financial, accounting, tax, legal, or compliance advice or guidance. Please consult a professional adviser for guidance on your specific situation.