A commission compensation agreement is a payment contract in which the employee earns a percentage of the sales that he or she makes. Establishing fair compensation for your sales team can help you attract the best people for this challenging job, which requires determination, the ability to persuade others while building trust, an appealing personality, and expansive product knowledge.

Basics of Sales Compensation Agreements

Many employers opt to use a commission-only compensation agreement because of the low risk; they only need to pay the salesperson if he or she generates profit.

Companies may use various formulas and guidelines to calculate commissions. For example, service-based businesses may offer a flat fee for every customer appointment completed. Other businesses pay a profit percentage. Variable commissions include incentives for high sales volumes; for example, a flat rate of $30 for the first 10 products sold, $40 for the next ten, and so on. Residual commissions are provided for active accounts; for example, an insurance agent who signs a new customer may receive a payment each month they retain the service.

Value of Sales Compensation Agreements

While salespeople can make substantial profits on commission, the industry by nature provides an irregular income. This means that commission compensation agreements can lead to risk for the employee. Before accepting a sales position, carefully review the compensation agreement so that you understand what to expect.

Compensation agreements are beneficial when:

  • You want to establish a new employee's rights and obligations and he or she will be fully or partially paid on commission.
  • You have accepted a new sales job and want to make sure the terms of the position, including commission, are documented.

This agreement includes a description of employee roles and responsibilities, commission percentage and terms, salary amount where applicable, and in some cases, non-compete and confidentiality clauses. Establishing formal terms with this type of agreement can help prevent future misunderstandings.

A flat-fee salary arrangement is not recommended for sales employees since they may not be motivated to produce without an incentive. Consider offering a salary plus bonus arrangement if you want to supply your employees with steady income while providing a financial incentive to perform.

Draw Scenarios

Some employees and employers prefer a draw arrangement in which the salesperson is assigned a threshold, such as $1,000 per week. If he or she does not meet that threshold in commission, the draw payment is made. If the draw payment is exceeded, the salesperson keeps the commission. However, the incentive is invalid if the employee rarely makes the draw.

Preventing Employee Lawsuits

In most states, employers have flexibility in setting sales commission terms and agreements, provided they pay out commissions as agreed. Vague terms can lead to confusion and disagreements. For example, how are commissions handled if a sale is refunded? What if a salesperson is giving discounts to create higher sales figures? In many cases, courts find in favor of the employee in cases like these.

Define how sales must be documented to receive commission credit and when payments will be received. Common methods of sales credit include:

  • When the product or service is ordered
  • When the product is sent
  • When the product is installed or delivered
  • When the company receives payment

If this is not documented in the commission agreement, courts usually use the order date as the default date for sales to be credited. Be specific on the methods and systems that employees may use to document sales. You should also create a recovery policy indicating that the commission is not received if the order is not paid for, canceled, or returned.

If your company uses a tiered commission plan in which different sales amounts are subject to different rates, make sure this is carefully explained and documented. If an employee files a wage complaint, the labor department will check the level of transparency you provided.

Update and review your plan each year so it reflects changes such as evolving employee roles and new laws. Compensation experts, including attorneys who specialize in employment and related areas of law, can review your plan to make sure it covers your bases.

If you need help with developing a commission compensation agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.