Structuring Your Sales Leaders Compensation Plan
As the owner and CEO of a rapidly growing IT staffing firm you have many hats to wear but the core focus should always be on scaling the business for long-term sustainable, predictable revenue growth. That includes hiring a sales leader who can scale the sales organization. One of your tasks is coming up with the right compensation plan for your sales leader.
As most owners have discovered, sales management compensation is often a delicate balancing act. If you pay too little you risk struggling to recruit and retain top talent, the kind of talent that can take your IT staffing firm to the next level. If you pay too much however, you will likely struggle to scale because of the expense and/or lack aof proper incentives. The key of course, is to find a happy middle ground — a place where your entire sales organization feels motivated to deliver results that fuel sustainable growth. Here are some tips and best practices for structuring your sales leaders compensation plan.
Before digging into the details for structuring your Sales VP’s compensation plan you first must understand what you need when you need it. Customers ask me all the time, “Dan, what is the best way to structure the compensation plan for my sales manager?” The answer depends on the growth stage of your company and what your specific goals are. For the purposes of this blog post, I’m going to share ideas for structuring a sales leader’s compensation plan for an IT staffing firm under $20M in revenue. I will refer to this as the customer acquisition growth phase. The reason for this is because most firms under $20M are getting 80% or more of their revenue from just a couple of key accounts. Naturally, they're in customer acquisition mode.
Establish Meaningful Business Objectives and Tie Them to Your Compensation Plan
The first thing to understand about sales compensation plans is they're all about driving your desired sales behaviors. Your ability to tie individual performance criteria to your company's broader growth objectives is crucial for success. I hear so many sales leaders and owners complain by saying things like "we need more new accounts but I feel like our sales reps are content because they get paid on all of their residuals and are not motivated to go open new accounts." Sound familiar? If that is the case than you need to change your comp plans. You don't need to stick to the same comp plan because it's "industry standard" or "it's how you've always compensated your sales force." You need to clearly identify and define sales behaviors that support your larger business objectives. Doing this will allow you to design a sales incentive program in which the sales force is motivated and rewarded for behavior and actions that support the execution of your company strategy. By taking the guesswork out of the definition of successful sales behaviors you will eliminate ambiguity and provide clear marching orders to your troops as to what you expect and how they get paid.
Before you hire your VP of Sales you need to first establish clear and meaningful sales goals and objectives including a quota for the Sales VP and his or her team to hit. A few things to consider:
- Is the goal to focus purely on bringing in new customers?
- What about up selling existing accounts? Is that a goal and if so, should it be rewarded (reps/sales VP be compensated) the same as they are for acquiring new accounts?
- What if the team achieves their revenue quota but does it at a deep discount and the profit margins erode? How will you compensate your sales leader under that scenario? Your sales reps?
These are just a few scenarios that you need to think through but this is what I mean by clear and meaningful sales objectives. I can tell you that 90% of the compensation plans that I see for sales (and recruiting) managers are simply overrides (anywhere from 1%-5%) given out on the total gross margin generated by the sales team. This structure fails to drive and encourage the right leadership behaviors. For instance, suppose my sales rep Dan does $10K in GM in April 2017 and as the owner I pay out Jim my sales manager a bonus or override of 2%. Next month Dan again does $10K in GM. Why would I want to continue to pay my sales manager a bonus on this? I wouldn’t because there was no growth.
When it comes to compensating your sales leader (and recruiting leader), I suggest you establish a quota and compensation plan based on growth. Here are a few examples to consider:
- Revenue Growth (Prior Year QTR to Current Year QTR)
- Gross Profit Growth (Prior Year QTR to Current Year QTR)
- Net Profit (net operating profit or contribution) Growth (Prior Year QTR to Current Year QTR)
These are the simple and obvious places to start and I urge you to err on the side of simple. There is a fine line between simple and complex and when compensation plans become too complex (for people to understand) they become demotivating.
As for the measurement period, I like to do an “apples to apples” comparison. So if I was paying my sales leader for Q1 2017 I would look at revenue, GP and Net Profit results for Q1 2016 and I would compare them with the results from 2017. The bonus payout would be tied to the growth percentage for each category over prior year. You can weigh each category differently to incent certain behaviors more than others. This means you could have a higher payout for revenue growth vs. gross profit growth vs. net operating growth. Being in the customer acquisition phase, it might be a good strategy to weigh revenue growth higher than gross profit growth. Finally, and most importantly, if there is no growth for the measurement period there should be no bonus payout.
They key here is the compensation is built around and paid out only when the company grows. Growing the company is what you pay your leaders to do and this is much different than simply paying out on an override. With an override the manager is going to get a bonus regardless of how hard they work or how effective they're coaching is. Heck, they may not even be coaching their sales reps or recruiters but they still get rewarded for it! A compensation plan focused on growth is also scalable. If you continue to pay out on overrides and there is no growth you will go out of business. Remember, the job of the sales leader (same goes for Recruiting leaders) is not to generate revenue but grow revenue by developing their people so that the business can grow and scale.
Compensation Through Equity & Phantom Stock
You may also consider equity or phantom stock options. Paul Bardaro, Partner and CPA of the professional accounting firm Rucci, Bardaro and Falzone says "Phantom stock can be a highly effective compensation tool. Employees are allowed to enjoy a sense of ownership in the company and share in its future success without necessarily sharing in the voting control, profits, dividends or distributions that normally accompany the issuance of legal equity. From the employee’s standpoint, the potential financial reward of participating in a well-designed phantom stock plan will closely mimic the payoff of actual equity or options (hence the names “mirror stock” and “shadow stock” that are sometimes used to refer to these plans). Yet many of the risks and liabilities ordinarily incurred by executives and others with direct, legal equity ownership are avoided with this pseudo version of company stock."
If you decide to go the equity route I suggest you speak with your banker or CPA. For early stage companies you're generally looking at the 1-5% range but how much equity to offer depends on a number of factors.
Other incentives to consider for giving your sales leader additional upside compensation could include:
- Overall quota attainment (if all reps or a certain percentage of reps hit quota the leader gets a bonus. A good leader doesn't rely on only 20% of their sales force to make their number)
- Improved win rates
- Shorter sales cycle
- Increased sales velocity
- Increased employee retention
Determining On-Target Earnings (OTE's)
Another key step to be considered before you interview and hire your Sales VP is determining the on-target earnings. In other words, you want to establish what their earning should be if they hit their sales targets such as growing revenue, gross profit or operating profit by X percent. To do this you I suggest you make sure you understand a few things about your market such as:
- How are sales leaders at my competitors being compensated for running a book of business similar in size to mine?
- How much are they being paid in base salary? Variable incentive?
- In general, how much are employers (outside my industry) paying sales leaders to run a book of business similar to mine? What is the total on-target earnings?
- How fast are my competitors (same size firm) growing?
- How fast has my firm being growing over the past few years?
The answers to these questions will help you understand the competitive landscape and focus in on the total on-target earnings. It will also help you determine how much growth you can and should expect from your sales leader, but don’t stop there. In other words, don’t put a ceiling on your growth. For example, if you discover through your research that the mean salary for a sales leader in your market is a base salary of $90,000 and a total package including incentives of $160K, don’t cap your growth and your sales leader’s compensation at $160K. Do you really care if you end up paying your sales leader $250K or even $400K if your sales leader brings in “X” more in revenue than you had expected? You shouldn’t. So I suggest that you fill the compensation plan with incentives (payouts) for hitting growth milestones above and beyond your wildest dreams. Good sales leaders will recognize this.
Base Salary to Variable Incentive Ratio and Draws
I suggest you evenly split your on-target earnings 50/50 between base salary and variable incentive. The more that you can leverage or tie compensation to actual sales results the better off you and your team will be. Compensation plans heavily tied to performance provide huge upside for revenue growth and allow ownership to truly leverage their people. Most importantly, the people are given the opportunity to make significantly more money than if their income was tied primarily to their fixed base salary.
Many candidates (sales leaders) will ask you for a guaranteed salary or draw, often ranging between 6 and 12 months. They justify this by saying they’re leaving a good paying position for risky one. Naturally they want compensation to bridge the gap until they’ve built their team and a big enough pipeline to hit their target. This seems fair and reasonable but it’s not the right move for the owner.
What’s important is that the total on-target earnings is high enough to attract and retain your sales leader. What shouldn’t factor into the decision making process is the delayed gratification of being paid out on the bonus. After all, why is the candidate looking to make a change anyway? Remember, you’re hiring your sales leader to perform and deliver results but when owners put their sales leader on an over inflated base salary or a long-term draw they send the wrong message and drive poor behavior. Draws don’t create urgency, they drive complacency. That being said, you do have to make sure your on-target earnings pay out well and that your pay out bonus for exceeding the goal is even better, much better. Your on-target goal should be a goal in which you have about 60% confidence your sales leader can hit. Your stretch goal for going above and beyond should be a goal you have about 15-25% confidence that your sales leader can hit. This should be an extremely handsome payout. Again, you can’t skimp on the payouts! You must pay for their performance if you expect to attract and retain them. This will appeal to high performing sales leaders. It will not be appealing to weak sales leaders.
If you are going to do a draw just make sure the sales leader has to make it up down the road by hitting a higher sales quota and/or sticking to a shorter draw if possible.
When your entire sales team is in total alignment with their compensation plans and their compensation plans are primarily tied to the achievement of specific growth goals than everyone will be incented to perform the level of activity and execute the desired sales behaviors that produce those results. The value that you place on specific performance metrics can and should vary but the idea and goal is to create a sales culture that drives urgency and rewards performers for meeting and exceeding targets.
How are you compensating your sales and recruiting leaders? How content are you with the performance and results of your leaders, perhaps your compensation plan need a reboot?