6 Rules for Startup Sales Comp

6 Rules for Startup Sales Comp

Originally posted at DKParker.com

I get asked a lot about sales compensation and how to hire sales people for startups. I’ve written before about not hiring a sales person too early here. Your first sales person is going to be the Founder. If the Founder can’t sell it, a sales person won’t be successful either.

Let’s start with the fact that, in general, being a Sales Person is a tough job. Products don’t sell themselves and a sales person spends a huge percentage of their day choosing the self-inflicting job of accepting rejection for a living! For doing what most humans don’t want to do, the good ones get paid disproportionately well for their efforts. New products add a level of complexity to their effort as well; most new products require an educational sales process (multiple demos, customer testimonials, etc.) because people don’t know your brand or product. Educational sales process = time.

The Founder has the vision for the product and, in most cases, that vision is blurred between what features actually exist and are sellable today and a blurry vision of the future for what the product will be in a mature state. This blurry vision can often mask all of the blemishes of the product in its current state. Hopefully, the Founder has been doing the early sales and knows how this current state impacts the sales effort. One other note, customers will also react differently to Founders than to sales people.

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So there you have the setup for the epic battle – in one corner, the Founder that doesn’t want to pay anymore than they have to for a sales person. In the other, the Sales Person who knows their day will be full of demos and rejections and thinks that without them, sales will be zero, so they should get as much of the cash in the transaction as possible.

1. It starts with the numbers:

Early stage companies often don’t know their KPIs, Key Performance Indicators, well enough to draw strong conclusions. So you have to recognize that you are forming a hypothesis that will be changing over time. And when you find out your hypothesis is wrong, you’ll need to make changes in the comp plan. See, Picking a Structure that Works below.

Pricing, I’ve written about the mystery of product pricing here for more detail or here, about not starting pricing too low. The summary for this post is that your pricing has to balance between competitive market price and high enough to pay someone to sell the product. Or the direct sales model that you are anticipating here won’t work.

Free isn’t an option if you have need a sales team. Discounted or a period of time is a marketing option, but you can’t support a sales team without a big cash balance or revenue to pay them for their efforts.

Three of the KPIs you need to use (or guess) are:

  • Life Time Value or LTV of the customer. How much will the customer pay for your product over a set period of time? In a mature state, you’d calculate it over a 36 month period. For an early stage company, I’d calculate it over 24 months or less. This will change as you have more data.
  • Churn, initially you’re going to have high churn because the product may lack the features the customer wants to continue to pay for the use. Sales people aren’t in charge of churn.
  • Gross Margin or GM, ideally you’ll be able to know how much margin is in each sale.

This is where the spreadsheet work needs to get done. The total sales expense will be 15-20% of total revenue (not including marketing), but including fully burdened overhead (benefits, expenses, office).

2. Transparency & Motivation

There has been some recent research about how random motivation is good for employees. I’m not sure I agree with the research, but I can tell you that it doesn’t apply to sales people. They need to know with certainty that the tasks they are completing will result in compensation. They need to be clear on why they are getting on the phone to get another “no.”

There are many aspects the Sales Person doesn’t directly control:

  • Product releases/updates/features – that means they can’t sell the future, they have to sell what they have today.
  • Pricing – you may give them some discount ability, but the Founder and marketing team should be setting pricing.
  • Churn – the only time a sales person controls churn is when they are selling the product to the wrong customer – that is just a bad sale. If the sales person continues to sell this way, it’s a problem with the sales person who will need to be terminated.
  • Collections – you don’t want to have your sales person doing collections on accounts, you want them to sell new accounts. Don’t pay reps until payments are received, but don’t make them accounts receivable

They are only in control of their activity. Use Salesforce.com to track the sales process. Leads need to convert to opportunities. Opportunities have stages (especially in an educational sales process). Don’t know the process yet? You’d better figure it out before you hire a sales person.

Time is the other factor here. The payoff for the sales efforts needs to be in the same month – not a quarter or a year. A sales person can’t see a quarter or more out – let alone a year – unless it’s a huge transaction size with a corresponding huge commission. Not your average comp for a startup.

By the way, I know you don’t want employees talking about what they make… but they are going to anyway. You better make sure that everyone is on the same plan.

3. Balancing Base Salary and Commission

You are generally going to have to pay “market rates” for salary based on your market and industry. That is still true if you have very few competitors and you’ve innovated a new product.

You can build a scalable sales team or you can throw some interns with “mud against the wall” and see what sticks. I’m not a fan of the intern method. What I mean here is that you hire a few-bunch of new sales people at minimum wage or commission only and see what happens. It’s really hard to forecast that in your model and when you finally cut over to a scalable team, you’re going to be in for an economic shock. I’ve seen companies succeed here, but I’ve seen more fail in the same effort.

In sales comp, you should set a Target Compensation – let’s pick $48k as a basic number to work with – the sliding scale now becomes the mix of salary to at-risk compensation, usually commission or bonus (depending on the market and tax status). In this case, base is at or near market rate for the position, given the industry and market.

The blend starts at 50/50 or $24k salary and $24k commission. This assumes that the product is relatively straight forward to sell and that the sales process is more predictable. If that sales process isn’t predictable, you’ll likely have to be more of a 75% salary, 25% commission. If you’re super early (or too early) in your product release cycle, I’ve seen the split be 90% salary and 10% commission. That usually means you hired the reps too early.

There are rare circumstances where commissions only work, e.g. it’s a person that doesn’t need a base salary, but still wants to receive compensation for their efforts.

4. Aligned Incentives

This rule sounds pretty obvious, but I can’t tell you how often it’s missed. I remember once, early in my career, when I was working with a compensation plan that was capped. I can’t remember what the percentage was, but if I hit the maximum goal for the year before the year end, I was no longer paid commission until January.

I remember the conversation with our National VP of Sales. It was mid October, and we had a passing meeting in the hall. His comment to me was basically, “Great job this year, you’re killing it, just a big push for the end of the year.” I remember saying that I was at my maximum commission for the year and was actively asking customers if they really needed the order this year or could just as easily take delivery next year. He was shocked, but the fact was that our incentives were not aligned – that is a bad compensation plan. So when I’m asked about capping commissions, my answer is always, “No.”

Avoiding “Unintended Consequences” is another way to look at this topic. Sales people are defined by their compensation plan, not their job description. Sorry for the surprise, but they will do the things that benefit them. So make sure that your incentive plan doesn’t drive any strange behavior. If it does, that’s your fault, not the sales reps’!

5. Picking a Structure that Works

It’s important to pick a structure that has longevity built into the plan.  You don’t want to be changing compensation plans every year, or worse a couple of times a year. Here’s an example using the numbers above.

  • Base salary – $2,000/month
  • Commission $2,000/month at 100% of Plan.
    • Usually paid on the 15th of the following month. You’ll need the time to close out the month and calculate the commission.
  • Quota is based on 100% of what is the attainable goal
    • There are two ways to incent on the slide scale – vs. a straight percentage basis, e.g. 125% of goal paying out 125% of commission. This single tweak will have a greater impact on driving sales behavior.
% of Goal% Payout
70%50%
80%70%
90%80%
100%100%
110%115%
120%140%
  • Depending on the base, being below a minimum (in the case above <69%) would payout a zero commission.
  • Above Goal should provide incentive to increase your number – vs. being a straight linear calculation.

6. What should the goal be?

Now that is the question! Here are some examples, based on what data you have and the stage of your company.

  • Total revenue per month
  • # of new subscriptions per months
  • # of pre-paid subscriptions per month (e.g. buy six months and get one month free)

Keep in mind that payout of commission is going to be paid only after the customer pays. You don’t want to start setting a precedent that sales reps get paid even if the customer doesn’t pay, that would be a slippery slope.

Need help with Sales Comp? Shoot me a note on the form below.


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