Sales Compensation Plans for Startups ($0-$10M)
I've received numerous requests to discuss sales compensation plans, so we developed a 3-part series to cover the topic.
“Show me the incentives and I’ll show you the outcome.” - Charlie Munger
Part One > 📌 You are here.
I've received numerous requests to discuss sales compensation plans, so we developed a 3-part series to cover the topic. Having a clear understanding of the incentive structure is essential. Charlie Munger's quote succinctly sums it up - having the knowledge of the incentives can help you accurately predict results.
This series starts with the evolution of compensation plans for companies as they scale from $0-$100M in revenue, moves into executive compensation, and concludes with advice on delivering messaging about compensation plans to your sales team.
As a founder starting a business with no revenue, it is essential to begin by selling your product or service yourself in order to understand the market dynamics. Attempting to hire a Head of Sales or sales representative without first having made successful sales may prove unsuccessful.
The following should be your objectives as a founder:
Understand your sales motion
Determine pricing and annual contract value
Close deals and gain testimonials.
There is a great article by Paul Graham called Do Things That Don’t Scale, and this is the exact mindset and approach relevant when acquiring your first paying clients.
Once you have achieved initial traction, you can progress to the next stage of revenue growth and consider hiring sales representatives.
Keep in mind that sales compensation plans are subject to change and you are not bound to your initial iteration. As your business evolves, your organization and compensation plans will require adjustments, which may be challenging to implement. Nevertheless, it is important to acknowledge this reality and be prepared to adapt as necessary.
To make sure the seller and the company have the same goals, it's essential to create a compensation plan that focuses on the desired result.
To attract and retain top sales talent, a company must offer significant potential for upside earnings. Sales compensation generally consists of a salary plus a variable component based on performance, collectively known as on-target earnings (OTE). For sales representatives focused on acquiring new business, the split between salary and variable compensation is typically around 50/50 or 60/40.
While equity may be appealing to the initial cohort of salespeople, it is not a sustainable option as the company grows. Therefore, a well-designed sales compensation plan can serve as the primary driver of outcomes in the sales department.
PRO TIP: If you’re hiring your first sales rep, read our previous blog post on the topic here
Pareto Principle
The Pareto principle, also known as the 80/20 rule, states that 80% of the consequences arise from 20% of the causes for many outcomes. This principle is particularly evident in startups, where a small percentage of sales representatives and clients generate a vast majority of the revenue.
It is crucial to consider these figures when forecasting sales and hiring new sales reps. To mitigate the impact of high turnover rates, it is advisable to hire more than one sales representative at a time. This approach ensures that the loss of a single rep does not significantly hold back the company's progress.
Simplicity
In a previous post, I emphasized that sales reps should be able to comprehend their compensation plan within 10 seconds; otherwise, it may be too complicated. While this statement is somewhat exaggerated, it highlights the importance of simplicity, particularly for startups.
As a general rule, your compensation plan should be concise enough to fit on a 3x5 flashcard. This approach serves as a mechanism for keeping the plan straightforward and uncomplicated.
Start with your business’ north star and work backwards from there. Your sales rep should be incentivized to help achieve the company's ultimate goal. For many clients we’ve recommended focusing their first compensation plan on getting transactions booked no matter the size of the deal. Keep it simple.
Guarantees
Sales roles typically offer a base salary and potential on-target earnings (OTE) for meeting sales targets. Avoid overstating OTE to attract sales reps; instead, be realistic and transparent.
If your company is just beginning to hire sales reps, you have many unknowns. For the initial 2-3 months, provide a guarantee and set goals. Inform your initial reps that you'll be creating a compensation plan the following quarter. Track key metrics, measure results, and stay focused on your goal.
Pay Structures
Customer centricity should be a top priority for startups, especially in the early stages. In order to earn testimonials and build word-of-mouth momentum, it's essential to create a compensation plan that incentivizes customer success. Here are a few different compensation plans commonly used by startups:
Base Salary with Short-Term Guarantees: While short-term guarantees are recommended for onboarding sales reps, it's important to set up performance-based incentives as you scale
Salary with Fixed Bonuses: Offering a high base salary with fixed bonuses ranging from $500 to $2k per transaction can be effective, but be mindful of the ratio between salary and bonuses, paying close to attention to whether it motivates reps to achieve your north star goals
Salary with Post-Sale Commission: If your sales reps are also responsible for customer success, consider a "hybrid rep" model that incentivizes both acquiring and retaining business. However, as your team grows, you will see new business sales reps who are bogged down with post sales work. This is a great way to start building your go-to-market motion as your sales hires will see the holes in the pre and post sales process, but you will inevitably have to reorg the team to optimize for specialization.
Commission-Only: Commission-only positions tend to have high turnover rates and are generally not recommended. Some startups explore the option of creating channel partners (resellers) with a large commission split, but this should only be pursued if you have a well-established sales playbook that can be followed by hired employees
Billing vs Booking
Sales reps can be paid when a deal is booked (signed agreement), when the company receives the cash, or when the company receives the cash and the claw back clause in the agreement has passed.
To optimize for new business acquisition at scale, you don’t want sales reps thinking about operational issues like collections, ideally, you’re able to pay sales reps their commission when an agreement is signed.
However, in the early days startups are sensitive to their burn rate and it’s possible the first compensation plan is structured as an acquisition payout along with incremental payments for customer success milestones and cash received.
With whatever direction you decide to go, be sure to pay timely and take care of these early sales reps. You’ll discover many issues in the climb to $10M in ARR and it’s on leadership to clean up the operations. At scale, if sales reps see operational issues getting in the way of deals as well as getting paid, they’ll simply move on to another company faster.
Protection Clause
You want all of your sales reps to succeed. The best sales reps analyze their compensation plans and figure out how to optimize for maximum reward. Each rep is generally expected to reach goals within a certain period of time, and it’s possible that a great sales rep will be able to meet goals much faster than you may have anticipated which in turn means you may have to pay your rep more quickly than your budget allows for.
On one end, this is great, as you have an individual that can overproduce what you originally thought possible. However, this can legitimately impact a startup’s forecasted burn rate by a significant margin.
Put a protection clause (commission cap) in place to make sure you’re optimizing for your north star, but not putting the overall business at risk due to massive over performance of an individual sales rep.
👉 Up next in this 3-part series: Sales Compensation For Growth Stage Companies ($10M - $50M)