On January 1, 2013, California’s revised Labor Code §2751 goes into effect. The code sets forth the requirements that companies must follow in communicating commission plans to employees who are in California. Interpreted conservatively, a commission is any incentive based on sales performance. The code states that the plan must be in writing, and it must explain how commissions are calculated and when they are to be paid. If a plan expires before a new plan is in place, the terms of the existing plan remain in effect until the plan is superseded or employment is terminated.
In order for the plan to take effect, it must be signed by the employer, and the employer must provide a signed copy to the employee. In addition, the employee must sign an acknowledgement of receipt of the plan. Of course, the employee has the option to refuse to sign the new plan, in which case the employer can terminate employment, stop paying any commission, or continue employment under the old agreement. Employer and employee signatures can be electronic. Although not specified in the code, it is recommended that electronic signatures comply with California’s Uniform Electronic Transaction Act (UETA).
Although the code does not specify penalties for noncompliance, legal experts see the terms as favorable for plaintiff lawyers. It is possible that failing to abide by the code could be subject to the penalties specified in California’s Private Attorneys General Act (PAGA). Those fines are $100 per employee per pay period for the initial violation, and $200 per employee per pay period for subsequent violations. In addition, the court could place the burden on the employer to prove the terms of the contract, otherwise it will presume the employee’s commission calculations are correct.
The commission plan document should answer the following questions:
- When does the plan expire? If no specific date is given, it is recommended that you include language stating that the contract does not expire unless expressly advised by the employer.
- To whom does the plan apply?
- How is the commission calculated?
- How and when is the commission classified as being earned? You should define the time of earning as late in the sales cycle as possible, in order to allow for ample time to calculate and disburse the payment.
- When is the commission to be paid? It is recommended to follow California’s Labor Code Section 204, which states that wages earned between the 1st and 15th of the month must be paid between the 16th and 26th of that month. Wages earned between the 16th and last day of the month must be paid between the 1st and 10th of the following month.
- Are any amounts paid considered advances until certain conditions are satisfied (i.e. implementation for a software sale)? If so, it should be clear that you are recovering an advance on future earnings, not a commission that has already been earned. The circumstances under which advances can be recovered should be detailed in the document.
- What happens to unpaid commissions when employment is terminated? Labor code sections 201-203 could apply, which state that earned wages must be paid on the last day of employment for an involuntary termination or for a voluntary resignation with more than 72 hours’ notice. For a voluntary resignation with less than 72 hours’ notice, earned wages must be paid within 72 hours of the last day of employment.
- Does the employee forfeit any commission upon termination? It is recommended that the document distinguish between voluntary and involuntary termination. For voluntary resignations, it is likely that the provisions of the plan are enforceable. For involuntary terminations, the provisions of the plan could be more problematic, especially if it could be perceived that the employer terminated employment in order to avoid paying commissions. Either way, it should not be classified as a “forfeiture”. Instead, legal experts recommend stating that continued employment is a condition to earning the incentive pay.
We at The Cygnal Group are experts in sales compensation plan design; we are not attorneys. We recommend that you consult legal counsel to ensure your sales compensation plans comply with California Labor Code §2751 and all other applicable laws.
Primary Source: “Preparing for California’s New Sales Compensation Law”; a WorldatWork webinar presented by David Cichelli of the Alexander Group and Anne Brafford of Morgan, Lewis & Bockius LLP; September 12, 2012. The webinar can be found here and is available to members and nonmembers of WorldatWork.
California, a state already ahead of most in regulating calculation and payment of sales commissions, has put into law the requirement to document commission plans in writing effective January 1, 2013.
To be clear, this law would apply only to true commission plans, so sales incentives paid as a goal-based incentive would not be subject to it. For more on the difference between these two, see What is the difference between a commission and a bonus? (Note that a goal-based incentive is officially called a “bonus” by WorldatWork, the accepted keepers of the “Sales Compensation Body of Knowledge.”)
It is always a best practice to provide great plan documentation, and we generally recommend it take at least two forms, possibly three:
- The rollout presentation. This is often a PowerPoint document which provides an overview of the plan design, explains what is new for the updated plans, and makes it clear what focus, behaviors and results are needed to earn well under the new plans.
- The plan document. This explains the plan in further detail, ideally with good examples included. It is not general across all sales people, but specific to the person who receives it, and includes documentation of their own target compensation and sales goals. It also includes a section covering a range of contingencies (shared sales credit, crediting rules in case of transfers, provisions for leaves of absence and termination, management discretion clause, etc.). It needs to be technically correct in terms of the mechanics of the compensation plan, but also needs to be reviewed by legal counsel in all jurisdictions in which eligible employees live and work.
- The earnings estimation calculator. This is either built in to the compensation administration system as a feature, or provided as a stand-alone spreadsheet, often in Excel. It allows the incentive-eligible employee to enter sales goals and target compensation, and also possible sales results, and see the resulting compensation. (We love it when a comp plan is so simple that a calculator would be overkill, so occasionally we can recommend NOT providing a calculator. But for most businesses, a calculator can be a great tool to speed understanding of a new plan.)
These three communication tools are so vital to plan success that they are standard deliverables in all Cygnal Group Full Service plan design engagements.
For early stage businesses, your first sales hire is hard to do well. You don’t have a sales leader to help you confirm that your candidate has the right skills and temperament for the job. You’re not sure what to expect in terms of productivity. And you don’t have a pay structure or comp plan to tell you how much this person should earn, what kinds of special arrangements are needed (car, expense account), etc.
We’ll leave a lot of that to your other advisors and focus here on the compensation piece with the basic steps you need to complete to arrive at the right comp plan for your new hire:
- Your first step is to determine a reasonable level of total compensation for a sales person in your business — in the U. S., that’s what their W-2 says at the end of the year. This is undoubtedly tied, in the thoughts of company management at least, to how much the person will sell in that first year — the cost needs to be associated with a reasonable return. You’ll get better at that as time goes by, but you’ll have to start with some kind of working assumption based on others in your industry, leadership’s experience in selling your products or services, even to a certain degree the perspective of your top candidates for the role and/or a recruiter who may be helping you to fill it.
- Next you need to decide how the risk will be shared — how much of that target total compensation will be in a fixed base salary and how much in the incentive at target. For early stage companies, the fixed portion may be relatively low, even non-existent. 30% to 50% of the target total compensation is a good starting place. However, if you are trying to attract a well-established resource to bring their network, skills and experience to your company, you may have to offer a higher base since their choices include many with less risk.
- Since you know the target total cash and the base, you can subtract to determine the incentive at target. Your next step is to be very clear about WHAT you expect your new sales person to PRODUCE per year. This is usually measured in revenue dollars, but may be measured in units sold or even gross margin dollars in some industries. Whatever the measure(s), you need to design a plan that delivers the target incentive amount for getting to the productivity goal. This is most typically communicated as a commission (to calculate the rate, divide the target incentive by the productivity expectation). There’s more to consider in designing the payout table than this article can address, such as threshold levels of performance (below which no incentive is earne), acceleration and deceleration in payout rates at over-goal levels of achievement, etc. You will also need to be clear about payout timing (monthly, quarterly, etc.), and measurement periods (independent or year-to-date). But many early stage companies do fine with a straight commission paid monthly – a single rate based on the incentive at target divided by the productivity expectation (e.g., x% of revenue, y% of margin, $z/unit).
- Your last design step is to check the plan’s appropriateness across a broad range of possible levels of productivity, and be sure you’re comfortable with both the cost to the company as it relates to results and the income level for the sales person. You will very likely make some kind of adjustment after this review, which should probably involve someone from your Finance group or the company’s owner.
- Once you feel you have the right design, your next step is to carefully document the plan in a Plan Document to be signed by both the sales person’s manager and the sales person. Here, you should probably ask for a review by your legal counsel.
- And finally, determine how you will administer the plan – where the data will reside, what reports will be run, who will do the initial calculation, who will review and approve it, and how the information will be communicated to your payroll processors.
Then after you’ve been living with the plan for a few months or quarters, have a look again to see if it’s meeting your needs. Always include a clause in the plan document claiming the right to adjust as needed, then don’t adjust during the plan year unless you’ve got a BIG problem. But do consider adjustments each new plan year. As your business grows and changes, the perfect sales comp plan will also change.