How to design a sales commission scheme for your business

Sales is Different

One element of successful scaling that I know leaders struggle with is paying sales people. After all, aren’t they just doing their job? We’re all in this together, so why do they get paid first?

This sentiment shows up in three ways. The first is the boss decides a fair commission rate. There are several things to consider when creating a commission scheme and what seems fair is not one of them.

The second is to wait for the cash to come in before paying people. This may seem sensible, even necessary, but it points to poor planning. The uncertainty may unsettle a sales team and there are limited circumstances where this works.

The third is to meddle in the process. I once closed a £150,000 deal that took months to negotiate, only to be told that the commission was withheld. The CEO intervened to divert the payment into the annual bonus pool.

How to Design a Commission Scheme

There are three considerations for a commission scheme. These are profitability, the sales cycle and the industry standard.

Sales commissions must be affordable. The primary reason that problems arise is because the correct commission rate is not baked into budgets.

It is a myth that the best sales people will find your product market fit and wait around through several product iterations. Leaders must design and test the sales process themselves. Once it works you are ready to hire a sales team.

Commissions also depend on the sales cycle. Longer dated, enterprise sales attract higher commission rates. The higher risk of such sales requires higher potential rewards.

While enterprise deals involve more team members, closing them is a particular skill that needs rewarding. You won’t hire the right people without a clear commission structure and will lose them if you don’t keep your word. I didn’t stay long with the CEO who changed the rules.

The final consideration is what does the industry pay. A boss might believe that 10% commission is fair, but if the standard is 20%, they don’t attract the best talent.

Here is a range of commission rates for select industries from Smart Reach, which leverages US government data.

Where your business sits in the relevant range, depends on the frequency of sales and the importance of deadlines. For example, there is an urgency to fill a magazine with adverts, which may lead to higher pay outs.

Know Your Magic Number

Use the Magic Number to ensure you have an effective sales process in place. Remember to include all costs of sales in your calculation, including any post-sales services required to minimise churn.

With your process humming along, you can pay regular commissions based on closed deals, rather than waiting for the client to pay.

Sales people are like any others and want to know what and when they will be paid. The difference is they accept their pay will vary with their performance.

Nonetheless, they want to make lifestyle choices based on income. Any uncertainty over when they will be paid limits their freedom.

If you have not got the cash to pay commissions once a quarter based on closed deals, then it is too early to hire a sales team.

The only time you might match commission with cash flow is when salespeople have equity participation. This means real skin-in-the-game, not 0.1% of shares.

The Best Advice

One of the best pieces of advice I received about scaling a business is that sales people in startups are often the best paid. This reflects the importance of momentum when building a business, especially if you want to attract outside finance.

The boss may struggle to see this, but their reward comes later when the equity pays out.

Questions to Ask and Answer

1. What commission rate is factored into cash and profit forecasts?

2. How long is the sales cycle and do rates reflect the risks?

3. What is the standard commission rate in my industry?

I’m Simon Maughan and I write The Profit Elevator as a guide for B2B firms seeking faster growth.

Designing a compensation scheme, including commissions, bonuses and equity, is part of The Cash Flow Calculator.

This is the fourth of six systems in The Profit Through Process Planner. If you’d like to know more then please visit my website.

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