Tag Archives: Long-term contracts

Payment timing for multi-year deals

    Question

    Our sales people sell long-term deals, most of which span several years. When should they be paid for these – upon signing, as invoiced, when revenue is recognized, at completion, or a combination of these?

    Answer

    We have seen several different compensation arrangements for long-term deals, which are often found in subscription businesses (e.g., SaaS, phone/internet service, online test delivery), and complex multi-year implementations requiring installation/configuration (e.g., enterprise software, utility infrastructure). Some businesses pay the sales people who sell these long-term deals all at once, and others stage the payment over time. The most common arrangements we have seen are listed below, along with some idea of when they are most valuable:

    Pay upon contract execution

    This is most common when the sales person is a pure “hunter” and there are project management or account management people in place to take the hand off after the contract is signed. The sales person has “done their job” when the contract is signed. And the value of the contract to the company is very likely to be exactly as expected at the time of signing.

    Pay as invoiced

    In this case, the customer may pay a portion of the agreed price at signing, then pay over the course of the contract, perhaps as milestones are attained, or perhaps on a regularly monthly schedule. Often the sales person will receive payment after each invoice is created. In many types of business this will also align with revenue recognition (when goods are shipped), but may not (especially in the case of software sales or professional services for installation). This type of payment policy will keep the sales person focused on ensuring the contract is executed as planned, and invoices are generated. It will also allow the company to better align the cost of the sales compensation with the income received. And in cases in which the contract is for a rate (e.g., for bandwidth used, hours of professional services, or tests delivered), it will ensure that the sales people is paid fairly for actual realized sales.

    Pay when cash is received

    If collection is often an issue, or if sales compensation cost must be funded directly out of cash receipts, a cash-based payment policy may be used. This will have the effect of focusing the sales person on seeing the transaction all the way through to collection. This is most commonly used in cash-flow-constrained early-stage businesses. Most more mature businesses find that well-written contracts and careful negotiation of terms, combined with customer-pleasing delivery and a capable accounts receivable function ensure the cash comes in; and they would rather have their sales people focused on selling than on collections.

    Pay when revenue is recognized

    Especially in the sales of licensed software, software as a service, and professional services associated with software implementations, revenue recognition rules come into play. It is possible for contract to be signed, and even for substantial cash to be received, and yet for the company to not be able to recognize significant revenue until a later quarter or year. When revenue recognition that is potentially out of alignment with order acceptance, invoice generation, and cash receipt is an important business goal, sales people may be paid based on recognized revenue.

    Pay portions of the compensation on a deal based on a combination of the above “triggers”

    In some cases, several of the objectives cited above may be in play. For example, there are new business “hunter” sales roles for which the “handoff” to the project management team happens over a six month period while implementation is under way. In such a case, 50% 0f the payment for the deal may be made following contract signing, and 50% following completion of implementation.

    Key principles
    1. Finish paying the sales person at the point at which you would like them to disengage and focus on the next deal for the typical deal.
    2. It’s reasonable and appropriate to include charge-back provisions so that sales credit and payment will be reversed if deals fail to materialize as anticipated. This should only be used as a fail-safe when such reversals are rare (well under10% of deals).
    3. The payout arrangement has to work for the sales person and the company – so if the company is cash-strapped, payment aligned with cash collection may need to be considered.
    4. Beware annuity “tails” – they create plan administration complexity, encumber the company years from now based on a plan designed today, and, over time, may create a situation in which current year pay is not tied to current year success for sales people.

    Paying for long-term contracts

     

    Question

    We sell long term, high volume contracts. Should our sales people be compensated through the entire term of the contract, or should they receive an initial commission which diminishes over the term of the contract?

    Answer

    The applicable principle here has to do with the definition of the sales job for those long-term contracts. If the sales person is expected to “account-manage” the account and ensure satisfaction throughout delivery (perhaps while also looking for opportunities to expand the business in the account), then payment over the life of the contract would be appropriate. If, however, the sales person hands off the signed contract to a delivery team and is expected to then begin to focus on the next opportunity, then completing payout closer to contract execution would be in order. And in between these two would be the situation in which the sales person’s role is expected to diminish over time, in which case a commission rate which decreases each year over the life of the contract would be appropriate.

    The rule of thumb is that you finish paying the sales person for the deal at the point at which you would typically expect them to disengage and move on. That said, the company may also reserve the right to reverse sales credit if the contract is cancelled, or if the eventual contract value is materially less than the value at signing.

    One major exception to all this is in the case of contracts for rates as opposed to fixed price contracts. If the contract is for a rate and the total volume is not known or committed to at the time of signing, it may be necessary to pay out as the business is invoiced over time.

    A significant disadvantage to paying out over time on long-term contracts is that it will tend to create a long annuity “tail” of payments which can serve to make sales people far more focused on managing those existing already-sold deals than on landing new ones. While some will argue that the annuity tail serves as a retention tool, consider who you are retaining with it. Those who expect to sell significant deals in the future would prefer the more substantial up-front payment and a “tail-less” plan. Those who prefer the plan with a tail would be those who prefer to create a comfortable cushion to mitigate their future risk.