Sales commissions are considered to be a tactical business tool to boost morale, employee performance, and productivity. Incentivising employees is important for all businesses and this makes it one business decision that is as important as any other. Sales commissions are based on numerous structures and executed according to the structure and associated goals of the business. However, noting that the business apect is not the only thing necessary to consider. We’ve drawn up a comprehensive guide about sales commissions structures and the legal aspects you will have to consider when choosing the right structure for your business.
Sales Commissions Structure
A sales commission structure defines and details how much your business’ sales team will be paid for each individual sale. Sales commission structures depend on a variety of factors, including business structures as well as the industry in which the business is operating, and the company’s business goals.
This structure is designed through keeping in mind your company’s commission budget, the benchmark achievement for sales, levels of salespeople, the base salary of the sales team, and other compensation benefits offered to employees. The two most commonly used structures are the base salary plus commission and the straight commission plan.
Base Salary Plus Commission
As one of the most common models in practice, this structure awards employees a base salary and a commission in addition to the base pay. This gives a salesperson both a fixed and variable salary component.
This structure is best suited for companies where the sales representatives’ retention and morale are vital for the success of the organisation. This structures allows for the company to offer rewards for record sales and therefore incentivises improved performance of employees.
However, one should note that under this structure, salespeople are seen as employees of the company rather than workers contracting for the company. This means greater tax expenses for the company. For smaller organisations, it also means taking on more expenses in terms of employee compensation, which is bound to have an adverse impact on the bottom line. Hence, businesses opting for this structure must weigh the benefits against the expenses incurred.
Straight Commission
Under this structure, employees are not awarded any base salaries and earn solely through sales commissions. With the lack of base pay, the commissions under this structure are generally higher than those under the base pay structure.
This approach is best suited for startups and new ventures. Companies do not have to guarantee salaries and only compensate for exceptional performance which contributes to the overall revenue of the business. They also benefit by promoting longer work hours, which earns the salespeople more remuneration without the company having to pay overtime. A straight commission also makes employees resemble contractors. With no base pay, the companies do not incur tax expenses and other benefits they have to pay to employees.
The disadvantage, however, is that the risk is too high and employee stability is low. Since compensation depends on an individuals performance, employees may not perform as per the company’s expectations making it harder to achieve business goals and milestones. Companies following the structure often witness greater turnover; while it is manageable for a short while, a shift is essential to maintain stability and retain a competitive talent pool.
Commission Calculation
While the structures dictate commissions and salaries which are to paid to employees, it is important to understand how they are calculated. Here are some of the most frequently used methods of calculation.
- Revenue Commission: Sales representatives are paid a specified percentage of the revenue they generate as commissions. This is the easiest to calculate and implement. Based on this calculation, greater performance is rewarded with greater commissions. However, this method has implications for the profits generated by the company.
- Margin Commission: Here, sales representatives are awarded commissions as a percentage of the difference between revenue generated and expenses incurred. This method proves beneficial where profits are concerned. It incentivises the sale of products which have a greater margin and discourages discounted sales.
- Tiered Commission: This commission structure allocates incentives for commission into various tiers. Sales in each tier is awarded a certain commission based on their allocation. Commissions increase as sales increase. While this motivates sales representatives to generate more sales, it does mean that businesses have to pay more commissions as sales increase.
Commission Agreements
A commission agreement is a document that details the terms and conditions and the commission structure an employee will receive. It also includes information about the tenure the employee will be serving, codes of conduct, evaluation metrics, compensation percentages, and a calculation basis.
Having such a document in place protects both the employee and the employer. It ensures both parties have consented to the agreement and prevents disputes from arising out of any miscommunication. A well-drafted and thorough document can protect your business from any legal proceedings that may arise in the future. Your commission agreements should ideally include the following:
- Rights and obligations of employer and employee/contractors
- Commission percentages and brackets based on products/services prices
- Commission calculation structures
- Payment terms, method, and time
- Non-disclosure clauses, codes of conduct
- Termination and Closure of the contract
- Dispute resolution methods
Having a well-drafted and detailed commission agreement helps prevent disputes from arising in the future. Any changes in the commission structure should be conveyed to the employee and mandated in the contract. In the circumstance where a commission structure is not covered in the contract, employees could sue the company for breach of contract if amendments are made mid-contract without a provision in place. Another dispute that could occur is, if multiple employees are involved in making a sale. In such cases too, commission agreements are critical in defining the share of commissions employees will get. Detailed commission agreements offer clarity with payouts and represent a mutual understanding of the compensation plan.
Only Paying Commissions
Under the straight compensation structure, employees are only paid the earned commission and no base salaries. While the structure is commonly used and has its advantages, it may not be permissible in some industries and sectors. Hence, as an employer, you need to consult with the modern award and enterprise agreements before choosing this structure.
Key Takeaways
- Sales commissions boost morale, performance, and productivity of employees.
- Employers have the option between a base salary plus commission structure or a straight commissions structure. Both of which are popular structures and used globally.
- Higher margins earn higher commissions.
- Commission calculations can be based on revenue earned, and tiered structures where different commission percentages are assigned to different revenue brackets.
Hire an Expert
While choosing a commission structure may solely look like the job for a business expert, you will need to consider the legalities too. Under the Fair Commission Act, all employees need to be compensated fairly.
Whichever structure you opt for, you will require a contract draft with the employee or contractors working with you as well as a dispute resolution procedure. The business lawyers at Lazarus Legal can help you draft contracts and negotiate legal formalities and rights. They can also consult you regarding the commission agreements you need to create for potential recruits.
Lazarus Legal has a team of highly qualified and experienced lawyers who can help with a range of specialist business and legal services. Connect with us today to discuss how we can help you with your legal matters.
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Mark Lazarus
Mark Lazarus, the visionary behind the business and the fresh blood of the Lazarus Legal team, Mark (or Laz as he is often known) owes much of his success to his past experiences. And he’s made it his personal goal to bring that wisdom and formula to the firm.