Commission or Profit-Sharing: How Should I Reward My Sales Team?Experts say the best compensation structure depends on your business and your goals.
Having the right incentive structure in place can have a major impact on employee satisfaction and retention — and your bottom line. But which compensation strategy will be most effective for your team depends on the unique needs and culture of your company.
Some businesses pay only sales commissions or only salaries. Others pay both. Profit-sharing based on the growth of the company is another option.
According to Ted Jenkin, co-CEO and founder of oXYGen Financial, which provides CFO guidance for more than 1,500 small businesses, the first step in determining the right compensation strategy for your business is to clearly define your goals for the company as a whole, and specifically for sales.
Commission based on sales targets tends to be the most common compensation structure, said Jenkin. “When you get metric-specific on the commission, it’s very clear to the salesperson what they’ve got to sell.”
The amounts awarded are highly dependent on the profit margins in the business, he noted. “I’ve seen them anywhere from 2 or 3 percent to as high as 20 percent.”
The length of your typical sales cycle will also influence your commission structure, said Ali Mirza, president of the sales advisory firm Rose Garden Consulting. For shorter cycles, a purely commission-based structure may be sufficient, he said. If you have a longer buying process, he explained, “it may take six months to close a deal. No one is going to stick around six months without any money.”
Salary plus bonus
Many companies provide their sales team with a small base salary with bonus awards for specific achievements. Mirza said this approach is popular among many small business owners “because they want to be able to give their salesperson a lot of security.”
In this scenario, Mirza suggested business owners award bonuses more often than annually. “People want instant gratification, so any commission or bonus that’s paid out later than a one-month time frame, it’s very difficult to get people to be pushing and selling towards those numbers.”
If retaining your sales employees for the long term is a high priority, Jenkin suggested setting up an Executive Bonus Plan under Internal Revenue Code 162. With this type of plan, you pay your employee a base salary and commission but also deposit a larger bonus in an individual vested retirement fund.
For example, he said, you could pay a base salary of $40,000 with a 3 percent commission on anything the employee sells. If he hits a set goal of $200,000 in personal sales, the owner would put $10,000 into an individual bonus retirement plan that would fully vest after five years of continued employment.
Profit sharing and phantom stock plans
Profit sharing is growing in popularity in many business circles, but it’s not always practical for small business owners, said Jenkin.
Both profit sharing plans and 401(k) plans and are governed by the Employee Retirement Income Security Act (ERISA), he explained, so they have very specific requirements and must be filed with the IRS — something too many small business owners don’t realize.
“The way to get around that,” said Jenkin, “is to set up something called a phantom stock plan.” Similar to a traditional stock option, this plan requires you determine a valuation for your company and use the same formula at the end of the year to determine the increase in the company’s value.
Jenkin shared this example from the employee’s perspective. Say your company offers you a bonus of 10,000 shares of stock, currently priced at $43 a share. “So a year later, when the stock is worth $53 a share, you essentially made money without having to put up any money.”
Using a phantom stock plan, he said, allows your employees to participate in the growth of your company without you giving away company equity. ”That is really the key because for a lot of owners in a small shop, you don’t really want to give away equity, but you do want your salespeople to act like they have equity in the company.”