As you go through this guide, download here a compensation modeling template that you can use for your endeavors. I recommend opening up the template, looking at the “instructions" tab as you read through the content below.
Eight Simple Steps to Achieve Comp Mastery
1. Pick Your AE Roles
Decide on how many sales roles you have. I detest custom compensation plans for individuals and insist on a consistent approach for a given account executive role — i.e., in general, we should offer the same base, same variable, and same quota. The exception is for when you are hiring for the same role but in an expensive location (i.e., SF) versus less so (i.e., Spokane). For the cheaper locations, you have an opportunity to reduce base, variable, and quota if need be. If you early in your company formation and sales hiring, ask yourself, “Can one type of rep role close most of my business? If so, is my business transactional or is it a longer value-based sell? If not, where would I draw the line between a more junior resource and a more senior resource? Where would I draw the line between an inside sales person (usually in a hub) versus a field-based person? You get the drill. Just define them and what you think the rough market segmentation is for that role. It will change over time, but it’s always good to be clear on your approach each year as salespeople love clarity and major change once a year.
2. Set Your Comp & Quotas
For each role, establish the appropriate base and variable and total on target earnings. Generally, for more junior sales roles, you will tend to have less variable as a percentage of total OTE (i.e., 50% or less) whereas, with senior field reps, they will want to crush their accelerators and want as big a variable as possible (>50%). Do keep note of your quota / total OTE ratios to ensure you are staying above 4x as a guideline. If you find that you cannot, you need to re-examine your overall product market fit — i.e., something is off (your average sales price is too low AND/OR your pipe gen is too low AND/OR your close rate is too low). For the model that I have provided, my ratios hover around five except for the enterprise role.
3. Pick your Quota Calculation Period
Be wise here. Monthly comp plans for highly transactional short sales cycle deals and annual comp plans for long sales cycle enterprise deals are easy to understand. If you are going to do quarterly, ensure the sales cycle lengths tend to be no more than 90–120 days. In the model provided, I do have a quarterly for a typical mid-market segment.
4. Decide on your measurement components
as you can see in the model, the three components that I care about for SAAS compensation plans are ACV, Cash, and Multi-year.
· ACV is defined as net new contracted annual value for license software (and sometimes premium support) for new or add-on business.
· Cash is defined as ACV / Billing terms where Annual = 1, Quarterly = 4, and Monthly = 12
· Multi-year is defined is the incremental ACV a customer commits to beyond one year at the time of signing. MY can also be calculated as TCV — ACV whereby TCV never includes one-time non-recurring charges like professional services.
For your sales segments, decide how important those components are for your business while also avoiding overly un-necessary sales friction into your deal cycles. In my pre-defined template, you can see that I have excluded multi-year as a component for the SMB inside sales business. Why? Because smaller customers tend not to want to commit to a multi-year agreement and we want those deals to move quickly. For that inside sales segment, I have split the AE’s variable between hitting their ACV number (80% of the variable) and getting Cash up front (20% of the variable). In the enterprise segment, where customers are used to demanding multi-year agreements and have no issue paying annually, I have included multi-year as a component. As a rule, though, until you are at your first few million in ARR, I would skip multi-year as a component in general as customers regardless of the segment do not tend to make a lengthy commitment to an unproven company/product.
For comparison’s sake, for the early years at salesforce.com, the compensation plans were AC = MY = Cash — which means the split of the variable was roughly 1/3 each. This approach made sense in the early days of SAAS where SFDC was not tapping the huge growth rounds of capital that are available today, and we wanted to secure longer customer commitments. However, understand what that meant to a rep — we were telling them that getting a year’s worth of cash up front and a second-year contractual commitment was as important as winning the deal — which can unfortunately highly motivate the AE to drop price more than needed to ensure they secure the cash and my components. This approach backfired a bit (and why I had to pull a full “house account” tricks) when we moved up-market, and AE’s were closing five year, 4M a year ACV deals, with two years cash upfront :).
5. Decide on your component performance assumptions
This is where you can get into trouble if you do not have enough data to set these correctly. When you first start adding these cash and multi-year assumptions, you should set targets that are achievable but not complete lay-ups. 100% for Cash means you expect to receive annual billing terms on 100% of your deals. 100% for Multi-Year means that you expect to receive one additional year in 100% of your contracts. If you are selling a mainstream SAAS product, generally enterprise customers will agree to a minimum of 2 years, and most customers across segments (except in a very transactional or self-serve SMB business) will agree to annual billing terms.
To make it fair to your reps, always in my view set the target slightly below what you think is achievable here because 1) you are not trying to put one over on your reps and 2) you are trying to reinforce great behavior from the reps. I promise you that the second these types of plans and assumptions are in place, your reps will go to customers and explain the standard contracts you sign are “three years, annual payment terms.” This “rep empowerment” + a discount calculator that shows a customer how much their price increases for shorter commitments on contract length and billing terms = a very happy place for your head of finance and head of success.
6. Review your Component Quota Amounts
You have now created separate quota buckets for each of the components you have decided to incorporate into your rep’s plan. Every deal they close can contribute to each of the quota buckets for credit depending on the specific deal attributes. For example, if you have decided to compensate based on ACV, MY, and Cash, your sales reps now have three actuals quotas, each of which they can overachieve. It’s a very simple construct they can understand as opposed to some multiplier for cash and or multiyear achievement applied to one base rate (usually tied to ACV).
7. Apply Your Accelerators
For each component (ACV, Cash, Multi-year), apply your accelerators and the shape of your acceleration curve beyond 100%. As you can see in the models I have provided, I have set the curve at 1x payout of the variable for 1x quota achievement and 3x payout for 2x achievement. As you play around with these curves, make sure when you look below on the actual payout percentages that you don’t have percentages that go down as you achieve more. You also do not need as many break-points. If you prefer fewer, just play around with the “payout percentage of variable” input such that payout rates are the same in the model for two or more breakpoints. Regarding the proper accelerators for cash and multi-year, my guidance is until you know better, flatten the curve a bit to avoid dramatically overpaying for over-accomplishment here because you set the target too low. At the bottom of each AE compensation plan sheet, you can see and share with your reps an example of the difference on what a rep can earn on a deal depending on how successful they are in negotiating the deal terms.
8. Decide on your one-time professional services payout rate
Until you are on your way, pay your reps for professional services. Pick a rate, somewhere between 3 to 5 % in my view.
That’s it. You have now designed compensation plans that are very similar to the model salesforce.com used for its first ten years or so. To make it even easier, use this word template, copy your achievement tables into it, make it your own, and get cracking.
The Most Common Questions People Have When Implementing this Model
How and when do we count a booking?
You should have a specific rule for this. For a signed deal to count for credit in a given month, the contract/order form must be signed in that month, and the order start date on the order form has to be in that month or within the first 15 days of the following month. Absent that, it is not a booking.
What if a contract is signed this month but starts later in the year?
Congrats — you now have a pre-booking. But recall, I don’t start paying commission or recognizing revenue until we can send out an invoice. You cannot send out an invoice until an order has been provisioned. As such, this counts as a pre-booking, and it should be recognized as a net new booking in the appropriate future month (see question 1’s answer
How do we handle ramped deals?
Remember — you receive ACV credit for periods in which a company is receiving incremental ARR. Calculating ramped deals can get tricky.
So for a hard example, let’s take a contract signed for two years, and the customer commits to A) 100K ACV to start, an B) incremental 100K ACV in six months and C) incremental 100K in 12 months with an agreed renewal price point of 300K after year 2.
Assigning component/timing credit would be computed as A) $100K in ACV with 100K in multi-year now, B) a pre-booking six months from today for $100K in ACV and $50K in multi-year, and C) a pre-booking of in 12 months of $100K in ACV and $0K in multi-year.
The Total Contract Value over two years is $450K or the sum of A value of $200K + B value of $150K + C value of $100k. To check our math as previously stated, MY = TCV — ACV and as such, $150K does equal $450K — $300K.
How do we handle pilots or opt-outs that customers demand?
These are not committed annuities. For an opt-out, you do not know the defined length of the agreement as the customer may opt-out. So, unless the opt-out is after one year for a multi-year agreement (in that case you get ACV credit, but MY credit is held until the customer elects not to opt out), it is not a bookable deal on which you can pay commissions. For example, if a customer agrees to a one-year deal with a two month opt out, the ACV credit can only be given after the two months when you are past the opt-out date. It is not a current ACV deal as a result. For that reason, avoid as much as possible “within one year opt-outs”.
A pilot is not a bookable event because there is no contractual commitment beyond that pilot. If pilots are a required portion of your business, try and have them pay for the pilot and if you want to throw the reps a bone on pilots, compensate the rep for what the customer pays you for the pilot as it if it’s one-time professional services. Do not retire any component quota for pilot payments.
What language doesn’t work in a contract?
More specifically, what language should be avoided to ensure we can pay our rep’s their commissions as they would like. For SAAS companies, there are two specific items that companies will push for that you must avoid at all costs: 1) Term for convenience & 2) Order start date/invoice sent when the customer goes live.
The first is obvious — if there is a term for convenience at any time, it simply is not a bookable event because there is no way to determine what the ACV, MY, etc. and no way to determine over what period to amortize the revenue and commission expense over. Just walk from those deals immediately — the buyer needs to know better.
We can all understand why the customer would ask for the second term, but that is simply not how SAAS agreements work. If you do agree to this term, it generally means you should likely not count the deal as a bookable event until the account has gone live — ie, when you can send your first invoice out.
What if it’s early and we have no confidence in setting a specific quota amount for a rep?
If you feel completely in the dark around what an appropriate quota should be as you are in the middle of product-market fit madness, that’s okay. You can simply multiply by four the reps desired base and OTE and see if that works for ACV quota, OR you could just pick a flat rate to pay on all ACV they close absent a quota — ie, the rep gets 15% of the first year ACV in anything they close.
What if we are not comfortable enough to set precise targets for cash and multiyear?
Again, I would likely say don’t sweat it and be as directionally accurate as you are comfortable in doing so at that point in your business. For earlier businesses that are capital constrained, setting a target for > 60% of your deal having annual billing terms (unless of course your product is a month to month type of offering) is not reaching. On the multi-year side, I generally recommend getting a year or two under your belt to understand your market segments and appropriateness of multi-year contracts for them before including this in your compensation plans.
What if the nature of our product and offering is low friction/month to month type of agreements?
The good news is that your compensation plans are much simpler. The bad news is that 98% of what I have written on the topic doesn’t apply to you. If these are month to month type of agreements, you likely are paying reps on something like the number of new accounts they sign up or as a percentage of new incremental monthly revenue. They key here is to pay reps for the work they do (ie signing up the account, expanding the accounts) and not to overpay them for monthly recurring revenue you already have.
What about additional sales incentives?
Most sales organizations like to run spiffs to drive specific behavior (more new business accounts, fast starts within a quarter or year, competitive swap outs, etc.) which is great. Understand that these generally can’t be tied to specific deals and easily amortizable and so they are treated as period expenses. In my view, start first with having a great sales achievement club at the end of the year + then add contests that pay out rewards outside of the comp plan — like gift cards, nice weekends away, etc.
How should I deal with the ramps of new reps in my compensation plans?
I like to be conservative in my ramps for brand new reps, especially for modeling purposes of true assigned quota. My guidance is to take a conservative approach and then add one more month of ramp. Ultimately it comes down, per each segment, to the sales cycle lengths, your pipeline generation ability, and the complexity of your offering and corresponding rep’s ability to comprehend. For inside sales business that have short sales cycles and plenty of inbound pipeline, I could see a ramp of M1: 0, M2:50%, M3:100%. On the other end, for enterprise deals with 6–9 months sales cycles where a rep is walking into a cold patch with no existing pipeline, I would recommend: M1:0, M2:0, M3:0, M4:0, M5:50%, M6:100% if not longer. Just be smart and fair.
How should I compensate our sales managers?
I am a big fan of compensating sales managers on the same components as their sales reps — it’s odd to have a disconnect there but many do — so just avoid it. As such, a manager’s plans looks very much the same as their rep’s plan in terms of having the same components (ACV, Cash, MY) and component assumptions as their teams. The big difference really is in 1) setting the quota and 2) the breakpoints.
For a sales manager, usually I take the sum of the ramped quota of their reps and apply a discount of 10 percent as a minimum. The idea is that you are setting your financial plan (and associated expenses) to something less than 80% of assigned quota and your sales management team’s number should be somewhere between the finance number and the fully assigned ramped street quota of your team (more on this in my next piece!).
Next, as with a larger number across a number of reps, it is much harder for a manager to overachieve their targets than it is for one of their individual reps. As such, you set lower break points for acceleration in your compensation models. For example, instead of the second breakpoint being at 125% like it is in the AE compensation models I provided, a managers’ would be something more like 110%. Additionally, as managers should have higher bases and variables and significant more equity than individual account executives, you likely don’t have as steep acceleration curves for managers.
One last complexity point — if a manager spans across multiple segments of reps (who may have different component assumptions in their plans), you may struggle to figure out which components to use for that manager. In that case, use your best judgement for a component mix that makes sense across his/her teams.
How do I manage this in salesforce / other SAAS systems?
This is not as complex as one would think. In salesforce.com, use the amount field to represent your ACV on a deal. Create calculated fields for multi-year (you can grab from order start and end date on the quote / order detail ) and cash (you can grab from the billing terms on quote / order detail). If you do quotes and orders manually and don’t use an integrated CPQ system, just ensure you are tracking order start and end date and billing terms as custom fields. If you do use a tool like Steelbrick or any of the other myriad CPQ tools out there, you can configure them to calculate acv, cash, and multi-year automatically to your heart's content. Then to calculate the commissions at the end of each month, you can 1) always use excel or 2) use a SAAS compensation tool like Exactly Incent to easily calculate and administer your commissions. Some of these tools even have a “what if” calculator that your reps can use on their deals to model what their compensation would be if they closed the transaction.
I sincerely hope you find this guidance (and the models and templates provided) useful. Start using these tips and tool, make them your own, and soon you will become a SAAS compensation master. Good luck endeavoring and as always, feel free to send me your thoughts, questions, etc.
