Sales and Finance Both Want to Get Paid
Both sales and finance want to get paid as quickly as possible after a deal closes. The sales rep wants to collect their commission payment. The finance team wants to collect the payment owed from the customer. If a SaaS provider gets annual payments upfront from the customer, then both the commission payment and the cash collection can occur in the first 30 (or 60) days. Everyone is happy.
However, the situation gets more complicated when payments are made throughout the contract’s lifecycle. To aid with cash flow, many SaaS providers offer their customers options like semi-annual, quarterly, or monthly payment options. In some cases, the customer agrees to pay upfront but only after satisfaction of certain performance obligations, such as a successful go-live.
Extended billing schedules raise interesting challenges for sales and finance organizations. Does it make sense to pay a sales rep in full, upfront, for a deal if the business doesn’t actually collect the cash owed until 6, 9, or 12 months after the contract is signed? In other words, should commissions be tied to billing or collections?
- Bookings only – sales gets paid upfront, independent of the customer’s payments
- Billing – sales gets paid as the customer is invoiced
- Collections – sales gets paid as the payments are collected
1) Commissions are tied to Bookings Only
In the unlinked model the sales commission payments are processed independent of when the customer is billed and when the customer pays. A new contract is booked by the sales team, the appropriate commission is calculated by finance, and the payment is scheduled for an upcoming payroll cycle.
For example, Mary closed a one-year $100K SaaS contract on December 31st with ABC company. Mary is qualified to earn a 15% commission on the deal. The full $15K commission is paid out in the January 15th payroll cycle. Mary’s commission is paid upfront regardless of whether ABC company agreed to pay the $100K fee in one lump sum upfront or in a series of quarterly installments.
The unlinked strategy is attractive to the sales organization because the account executives realize immediate benefits from closed-won opportunities. Compensation policies are an important consideration for recruiting and retaining top performers. With upfront commission payments, the AEs do not need to worry about blowback from a botched implementation or shifting customer priorities. Nor are sales reps tied up with golden handcuffs that require them to stick around until the contract ends to reap the rewards of the deal.
The unlinked strategy can be less attractive to the finance organization for a few reasons. First, the cash paid in sales commissions are not aligned with when the cash is collected from the customer. The sales rep may get paid out in month one, but the revenue is collected over the span of a twelve-month cycle. Second, there is no guarantee the cash will be collected from the customer. The sales rep might get paid their commission in month one, but a performance-related dispute arises in month three that results in 75% of the payments never being collected.
Pay Upfront with a few Exceptions
There may be justification for delaying commission payments in certain exception scenarios. A common exception is delayed billing. Some SaaS providers may not send the first invoice to the customer until after implementation and customer go-live. Implementations for SaaS products come in all shapes and sizes. Some happen in a few weeks with relatively low complexity while other implementation cycles could last several months and have lots of external dependencies. The more complex the implementation the greater the risk of failure and customer payment dispute. As a result, it may be a smart policy to tie part (or all) of the commission to collections.
2) Commissions are tied to Billing
The sales commission is linked with the billing schedule. As invoices are issued to the customer account, the appropriate commission is calculated, and payments are scheduled for an upcoming payroll cycle. If the customer elected to pay once upfront, then the commission would be paid in one lump sum after close. If the customer elected to pay monthly, then the commission would be paid in twelve monthly installments throughout the year.
For example, Mary closed a one-year $200K SaaS contract on December 31st with ABC company. The customer did not want to pay upfront but instead over four quarterly installments throughout the year. Mary is qualified to earn a 15% commission on the $200K deal or $30K total. When the customer’s first invoice is issued in January for $50K, the finance team also initiates a payment to Mary for the 15% commission or $7,500. When the second invoice is issued in April for $50K, another $7,500 payment is made to Mary. The same process recurs for the next two quarters.
The billing-commission linkage is less appealing to the sales organization than an unliked strategy. There is a time delay in the account executive’s ability to collect the reward for closing the deal as the payments are distributed across the contract lifecycle. Many SaaS providers require the sales rep to be actively employed with the company to qualify for the payment. In these scenarios, the sales rep will lose out on earned commissions if they choose to switch jobs.
The linked strategy can appeal more to finance as it better aligns the cash inflows and outflows. The expenses paid in commission are better aligned with the revenue collected from the customers. However, note that because the commission payment is aligned with billing (versus collection), there is still a risk to the business. Just because a customer is billed, there is no guarantee that the invoice will be paid.
Alternative Approach – Clawback Policies
An alternative approach that keeps both sales and finance happy involves introducing a clawback policy. If the customer cancels the contract or does not pay the expected amounts, then the sales rep must return the commission payment. The clawback provision enables sales to get paid quickly after a deal closes and de-risks the non-payment scenario for finance. While the clawback sounds like an elegant theory in principle, it is challenging to implement effectively in practice. There is a lot of negative energy created by a clawback scenario within sales as word spreads about an AE needing to return payment. Ideally, the business should never have to claw back a payment. Instead, the real value is in the threat of a clawback, which helps provides an incentive to get the sales rep involved in aid with collections efforts.
3) Commission is tied to Collections
The sales commission is linked with the actual payment collection from the customer. As collections are received, the appropriate commission is calculated, and payments are scheduled for an upcoming payroll cycle. If the customer elects to pay once upfront, then the commission will be paid in one lump sum after the initial collection is received. If the customer elected to pay quarterly, then the commission would be paid in four monthly installments throughout the year.
For example, Mary closed a one-year $300K SaaS contract on December 31st with ABC company. The company did not want to pay all of the fees upfront but instead elected to pay a premium for monthly billing. Mary earns a 15% commission on the $120K deal, or $18K total. When the customer’s first monthly invoice is issued in January for $10K, the finance team also initiates a payment to Mary for the 15% commission of $1,500. When the second invoice is issued in February for $10K, another $1,500 payment is made to Mary. The same process reoccurs for the next ten months.
Linking commissions to collections is even less appealing to sales than tying it to billing. Since most customers enjoy Net 30 or 45 payment terms, the linkage introduces an even longer delay before the AE is paid. The linkage to collections, however, does offer appeal to finance as it eliminates the potential for a sales rep to be paid on a deal that the business never collects payment for.
Upfront Payment Incentives
Some organizations focus on eliminating the need for a linkage between collections and commissions, by creating upfront payment incentives. There might be an incentive for the customer such as a higher discount for an annual upfront payment than a quarterly or monthly arrangement. Alternatively, there might be a higher commission payment for the account executive to secure upfront payment terms. Some SaaS providers adopt both strategies to maximize incoming cash flows. Upfront payment incentives can be a better incentive than a clawback as they offer a carrot instead of a stick. Both the sales team and the finance team win.
Selecting the Right Commissions Policy for SaaS Billing
There is no perfect answer for how to link commissions with billing and collections. However, your choice of policy is often heavily influenced by the market dynamics, pricing strategy, and risk factors specific to your specific business model. Common factors that influence the choice of commission policy include:
- Pricing Strategy – Some products have a fixed monthly subscription fee that is known at the time of contract signature. Others offerings are priced with a variable fee that is calculated based on usage or a percentage of the dollar value processed. The variable fees can be estimated at the time of contract signature but are not known until the end of each billing cycle. If the pricing is predominantly variable, then it is unlikely that the commission payments will be paid upfront. It is more likely that commissions will be tied to billing and paid over time as the actual revenue generated from the account is determined.
- Account Management – Some sales teams only focus on closing business with new logos, which are then handed off to the customer success organization after booking. Other sales teams play an ongoing role in growing the revenue with the customer after the initial deal is closed through upsells and renewals. If the sales team is involved throughout the customer lifecycle, then there will not be one commission but a series of payments tied to ongoing upsells and renewals.
- Non-Performance Risk – Some SaaS providers offer free trials or monthly plans that enable customers to get hands-on experience with the product before committing to a longer-term contract. Others have more complex products that can be demonstrated during a sales cycle but require a customer-specific implementation to be performed before use. The risk of a payment dispute is much higher with implementations as the customers may discover the product does not support their use cases. SaaS providers with higher-risk implementations may elect to withhold some or all of the commission until they go live.
- Talent Strategies – Some SaaS providers have built strong reputations and brand names that attract top talent. Sales reps may be eager to work at high-growth market leaders to bolster their resumes or share in the success as the company scales. Other SaaS providers may be challenger brands that are struggling to attract high-performing reps. Market leaders that do not have a talent problem may be able to get away with less favorable commission policies tied to collections. Challengers may have to take on more risk in their compensation policies to get the right talent in the organization.
- Payment Methods – Some SaaS providers have relatively low fees that lend themselves to automated, recurring billing models via credit card or ACH transfers. Others have higher fees for which credit card processing might be cost-prohibitive. The cost of an annual SaaS subscription may exceed a certain dollar threshold that requires accounts payable approval for invoices. The risk of non-payment is higher with AP-centric workflows as the customer can withhold payment until they are satisfied with the service being provided.
- Administrative Complexity – Some SaaS providers have a large customer community, with hundreds or thousands of new contracts being signed monthly. Others might have fewer customers paying a higher average selling price. The administrative complexity associated with managing the payouts may influence commission policies. Tracking thousands of different payments tied to the monthly, quarterly, and semi-annual collections may be overly burdensome to the finance organization. May elect to pay all commissions upfront and set up exception policies for non-payment scenarios.