What is compensation and explain the types compensating salespeople?

Opinions expressed by Entrepreneur contributors are their own.

Your business is growing, and you've realized you can't do it all yourself. Because you want to focus on growth, you're preparing to hire your first salesperson.

Once you find the right candidate--and that's a subject in itself--how do you plan to compensate your salesperson?

Sales compensation is a tricky business; there are a number of payment models to choose from. You can pay 100 percent salary, 100 percent commission, commission with a draw or some combination thereof. Each method has its pros and cons.

A rule of thumb: Commissions motivate employees to sell harder, while salaries create loyal employees.

Before you can choose the right compensation model, you should weigh several factors, including the type of salesperson you want, the kind of product you sell, your target customer and the length of your sales cycle.

There are different types of salespeople, and they excel in different selling situations. In short, it all depends on what you're selling and who you're selling it to. See the article, " Finder, Minder or Grinder: What's Your Sales Style? "

Generally speaking, if you're paying 100 percent commission, you'll attract aggressive, independent "hunters." On the other hand, if you're offering a large base salary, you'll attract more security-oriented "minders." They may not be as driven, but they may excel at service and building relationships.

When compensation is largely commissions, salespeople tend to feel ownership of "their" accounts. As a result, they may be more prone to leaving you, taking your customers with them. In contrast, a salaried salesperson will not be as dangerously possessive. If you do base compensation on commissions, be sure to have a strong non-compete clause in your employment contract.

The Draw and its Drawbacks
Many small businesses start out by paying new salespeople a draw against future commissions. Theoretically, this operates like a safety net, tiding rookies over until they get their feet wet.

However, the drawback is that if your salesperson never gets up to speed, he or she will accumulate a large negative draw. How will he or she ever pay it back? As the situation spirals downward, that salesperson will either quit or be terminated. Either way, you're the one stuck with the deficit. And you not only lose the amount of the draw, but also your employee and the time invested in training.

If you do choose to use a draw system, be sure to cap the amount you will advance and set a time limit. Structure it as a declining draw, with the amount decreasing at scheduled intervals--say, every 30 days, with the draw eliminated after 120 days of employment.

Consider Your Sales Cycle
Employers like commission-structured compensation because it rewards employees purely on results. But beware: The longer your sales cycle, the less attractive commission-based compensation is for employees. When lengthy sales cycles prevent workers from maintaining an even cash flow, even top performers won't stick around.

While it's easiest to measure sales performance in terms of dollars sold, this doesn't work with protracted sales cycles. Often, it makes more sense to measure new salespeople in terms of their activity: how many calls they make, how many proposals they generate and how well they follow them up.

In fact, this also works well with salespeople collecting large base salaries. Identifying specific activities and creating measurable goals helps keep workers on track. It also makes it easier to measure their performance, a must regardless of your compensation method.

Striking the Balance
For most employers, offering a base salary with commission is the best solution, because it motivates performance while building company loyalty.

What's the ideal balance of salary and commissions? Studies suggest that a 50/50 or 60/40 split gets the best results. Of course, any formula should be tailored to your business or sales cycle. And whatever formula you choose, keep it simple and straightforward. A complicated incentive formula actually works as a disincentive.

A winning compensation formula will benefit both your company and your salespeople. It will inspire individual achievement, while strengthening your organization as a whole. When it comes to sales compensation, the best approach is to strike a balance.

• This Executive Director's Family Doesn't Support Her Work, But She Won't Stop Fighting for Underrepresented Creators

• Creativity Means Productivity. Here Are 3 Practices That Boost Both.

• I'm a Stay-At-Home Parent and Entrepreneur, and I'm Burnt Out. Here's How to Avoid the Same Fate.

• A Media Exec on How Brands Can Leverage OTT and FAST for Marketing Success: 'It's More Lean In Than Lean Back'

• You've Been Upgraded: A Simple Story That Helped Me Build Resilience

• Elon Musk Is Worried About Bots. You Should Be, Too.

• What I Learned From Pitching Marc Benioff My Startup at Dreamforce

Long ago, we wrote about the importance of a compensation plan in an organization. I thought we’d follow up on that post by exploring the six different types of compensation plans in depth. In many companies, basics plus bonus-based compensation plans are used as a way to motivate employees. Finding what compensation plan works best for the company, involves accessing its strengths and weaknesses, making a decision based on the long-term goals, and carefully negotiating the contract with the employee in a way that it works best for the company and its needs. We’ve picked the most common and most rewarding forms of compensation plans and highlighted their benefits and downsides, so you can decide which one works best for your business needs.

Types of Compensation Plans for Compensating Employees Beyond Commissions:

1. Straight Salary Compensation

Straight salary refers to the basic salaries and wage given to the worker. In most companies, the base pay is determined by the worker’s job title and job role.  The company sets a minimum and maximum range that can increase, decrease or remain the same, depending on the worker’s performance.

• Salespeople are usually paid on a straight salary compensation, in which there is no opportunity to earn incentives.
• Straight salary plan can help promote a sense of equality among sales people who work as teams or small groups, for everyone is paid equally and the contribution of each team member is also expected to be equal.
• A straight salary can greatly benefit someone who is transferring to a new territory. Once the person has established himself in the area, the company can switch to performance-based salary.

2. Salary plus Commission

This is one of the most reliable types of compensation plans. An employee who agrees to this type of compensation will receive a base salary along with an additional bonus if performance hits or exceeds earning goals.

• In most companies, the bonus is usually tied to a budget or other target that has little significance to the employee.
• Employees earning salary plus commission will have higher income tax rates than a self-employed agent.
• Employees are guaranteed to receive at least base salary to pay the bills, even during a time period when their sales are low.

3. Commission Only

This is a primary method for compensating independent sales agents. It is a highly attractive model, especially to start-ups who are seeking to penetrate a specific territory.

• In commission only jobs, companies offer a safety net in the form of “draw against commission.” The company pays its salespeople a set amount known as a “pre-determined draw” at the beginning of each pay period. At the end of the pay period, this prepayment is drawn from how much the salesperson earned in commissions. If a salesperson earns more commissions than he was paid, he keeps the extra money. If he earns less in commissions, he must pay the remainder back to the company.
• If an employee makes no sales during a month, he doesn’t get paid. However, successful salespeople tend to make a lot of money with commission than with a salary plus commission job.

4. Territory Volume Compensation Plans

This type of compensation is well-suited for employees who work in a team-based culture. The compensation is usually calculated by finding out territory volume. The sales numbers are added up and all commissions are split equally among all sales professionals.

• This type of compensation plan puts less pressure on individuals and fosters team-building.
• The only downside with territory volume compensation plan is that it can lead to hostility between co-workers if certain members feel that effort isn’t equally divided.

5. Profit Margin/Revenue Based Compensation Plans

Profit margin is one of the most popular types of compensation used by start-up companies. Under this plan, companies compensate its employees entirely on the profits made by the business. Due to the complexity and compliance issues involved, very few companies offer equity or stock.

• Startup companies using profit margin/revenue based compensation plan can also incorporate long-term incentives such as stock to build loyalty and a valuable sales base.

6. Residual Commission

This type of compensation plan is every salesperson’s dream. In this, salespeople continue to receive a commission as long as their accounts are generating revenue for the employer. Sadly, employers are usually reluctant to offer a residual commission deal to employees.

• Good salespeople can continue to receive residual commission ever after they leave the company through negotiation.

What’s right for you?

No two compensation plans are alike. Usually, the type of compensation plan an organization chooses, and the type that an individual accepts, depends on the market conditions and the goals of those involved.