Compensating Your First Sales Leader
I have been spending a bit of time on Quora to answer questions asked by early stage software entrepreneurs… all part of my role as an early stage software investor who is passionate about mentoring software CEOs and managers.
Here’s a question that was posed… and my answer…
We are launching a product/company entirely based on direct sales (B2B)- and we would like to offer equity and commission to our head of sales, because we want to give $$ both on the front end and back end. How might we structure this?
We are considering a vesting equity interest with some type of sliding scale - for example, 5% vested end one year, additional 5% upon total sales reaching x dollars, and then another 5% when sales reach perhaps 5x-10x dollars. On the front end we would like to offer a direct commission for each sale, perhaps 20% each sale revenue.
Is this a reasonable scale? We are wholly dependent on these direct sales - and want to produce the maximum incentive curve...
Any thought to psychological structure for this?
Great questions, and pretty typical issue for a start-up B2B company hiring its first sales leader.
Before I get into the answer, I highly recommend you read a post I wrote last year about the issues start-ups face when they hire their first rep.
Here's how to think about sales rep/manager compensation:
A typical sales person is mainly concerned with cash compensation. He typically thinks of options as nice to have, and he will rarely give up short term cash compensation for equity. That is why it is so hard to hire a strong experienced sales leader into a start-up… start-ups can’t afford them.
So if you have a sales leader who is willing to forgo cash compensation for equity (and he’s really experienced and qualified), you need to think of him as a co-founder and give him founder equity.
Otherwise, hire him and compensate him like any other employee you would hire.
To figure out how much you should pay him in cash, start by figuring out how much the sales leader made in the last year of his previous job. Ask him what his total take-home pay was... and how much of it was base salary vs. commission based. Then ask him what his total quota was.
Then figure out if you can afford to pay him his base salary. If you can, don't give him more equity than the market benchmark. If you can't, you will need to negotiate the amount of equity (more on that later).
Now you need to figure out if you can pay him his variable compensation. This is a bit easier because variable comp is directly tied to the cash you receive from your customers based on deals he closes. If customer revenue is the only source for paying your total expenses, you will need to figure out how much customer revenue you can allocate to your sales guy.
For example, if you expect the company to generate $500,000 in total sales in 2011, and you assume you will need to use $400,000 of it for other expenses, you are left with $100,000 you can pay him. If his total compensation for the year was negotiated to be $75,000 base and $75,000 in total commissions (if he hits quota), you pay him $75,000. If the company only generates $200,000… then you have a problem.
So don’t worry about the 20% commission. It doesn’t matter what you set the commission at when you’re starting. What matters is how much the company could generate in revenue, and is that enough for him to make the minimum money he wants to make.
My advice... if you can't afford to pay a sales guy what he made in his previous job, don't hire him. Do the selling yourself until you can. Sales people who don't make as much or more of what they made the previous year will be miserable (and likely to leave) no matter how much equity you give them.
So now let's talk about equity... I always thought sales people should not receive much equity if they are making a total compensation that is within market benchmarks, and equal or more to what they made the previous year.
But in the US, sales people are provided with equity options (as are all employees), so I will not push this point too much.
For companies that are past the start-up phase (revenue already being generated, reasonable profitability or available outside funding, etc.), here's the typical option allocations to sales people:
- VP of Sales (managing all of sales): 1-2%
- Sales Director (managing a sales team): 0.25-0.5%
- Sales Supervisor (managing a sales group): 0.1-0.2%
- Sales Rep: below 0.1%
These percentages will vary based on the stage of your company (i.e. the risk the sales guy would be taking) and your ability to pay the sales person market baseline compensation. Again, if you can pay market compensation, be very stingy with options.
If you are pre-revenue, I recommend you don't hire a sales person. Sell yourself. You will learn a ton, and it's not hard to sell in the start-up phase. You know the product best; you are passionate about it, etc.
If you must have a sales leader, make sure it's a renaissance sales person (see my blog post above) and give him anywhere from 2-10% equity. Sure this represents a big range so it really depends on whether this person is senior enough to sit at the senior management table while helping you build the company. The lower part of that range applies if you're hiring a sales guy. Sales reps typically don't last more than two years in a start-up.
I didn't understand the vesting structure you were proposing... You should make it simpler. Build your vesting plan as you would for all employees. Four year vesting with 25% vesting at the end of each year.
I would not tie vesting to revenue...
Set the revenue goals with the sales leader and base them on the market you expect to penetrate and the resources you will allocate to selling. Within the first year, if you are not impressed with the sales leader or with the revenue he's generating... you will need to decide the real reason:
- He's not effective... if so, fire him.
- He's effective but your market/product is not ready... if you can afford him, keep him.
I hope this helps... You can also refer to OpenView Venture Partner's Labs website for more tips on managing sales teams. As expansion stage software investors, we are committed to mentoring software CEO's and their teams through hands-on operational support.
Peace to all...