If you have sales staff, you might pay them commissions. Paying employees with sales commissions can incentivize employees to make more sales. While commissions can get employees to sell more, employees aren’t guaranteed steady pay. To give your sales staff more financial stability, you can use a draw against commission system.
What is a draw against commission?
A draw against commission is regular pay you give a commissioned employee. It is essentially an advance that is subtracted from the employee’s commissions. If there are any remaining commissions after a specified time, you will give the employee the remainder. A draw is not a salary, but rather regular payouts instead of periodic ones.
For example, an employee receives a draw of $600 per week, and you give out the remaining commissions at the end of every month. When you give the employee their draw, subtract it from their total commissions. At the end of the month, you would pay the employee any remaining commissions.
Types of draw on commission
There are two types of draws against commission contracts: recoverable and nonrecoverable.
A recoverable draw is a payout that you expect to gain back. You are basically loaning employees money that you expect them to pay back by earning sales commissions. For example, if you give an employee a draw of $2,000 per month, you expect the employee to earn at least $2,000 in commissions each month. This way, your business doesn’t lose any money when paying the draws.
If an employee doesn’t earn enough commissions to cover their draw, their debts roll over to the next commission payout period. Hopefully, the employee will earn enough commissions in the next period to cover their draws.
You might have to create a policy to ensure the draws are recoverable. If the employee doesn’t earn enough commissions to cover the draws after a certain time, you might need a debt payback plan.
A nonrecoverable draw is a payment you don’t expect to gain back. You give the draw to an employee, but you don’t plan for the employee to earn enough in commissions to pay for the draw. Even if the employee doesn’t earn enough in commissions to cover the draw, you don’t hold the uncovered amount as the employee’s debt.
If the employee does earn enough to cover the draw plus extra, you will pay the remaining commissions to the employee.
Nonrecoverable draws are more common when a sales employee first begins their job. It takes a while for the employee to train and gain experience. The employee likely will not earn much in commissions at the beginning. After a training period, you can begin to make the draws recoverable.
Let’s say you hire a new salesperson. During their first six months, you pay them with nonrecoverable draws. The salesperson might earn enough commissions to cover the draws, but you plan to lose some money if the commissions aren’t enough. After the first six months, you begin paying recoverable draws. If the salesperson doesn’t earn enough commissions to cover the draws now, the unearned amount becomes a debt.
Draw against commission example
Let’s pretend you hire a sales employee. You pay them a draw of $1,000 on a semimonthly pay frequency. After the end of every month, you pay out any remaining commissions. The employee needs to earn $2,000 in commissions per month to cover the draws.
For the first nine months of employment, you pay nonrecoverable draws. Sometimes, the employee doesn’t earn $2,000 in commissions per month. Because you are paying nonrecoverable draws, you forgive any debts at the end of each month. When the employee earns more than $2,000 per month, you give the employee the extra commissions at the end of the month.
After the first nine months, you switch to recoverable draws. The employee must still earn at least $2,000 per month to cover the draws. If the employee earns more than $2,000, you pay the employee the remainder at the end of the month.
If the employee earns less than $2,000 in commissions during the month, the unearned amount becomes a debt. Let’s say the employee only earns $1,500 one month. The $500 the employee didn’t earn becomes a debt. The following month, the employee must make $2,000 in commission, plus an extra $500 to make up for the previous month. The debt keeps rolling over until it is paid off.
Why have a commission draw
A draw against commission system can greatly benefit your sales staff. The purpose of a draw on commission is for employees to receive regular, guaranteed income, which can improve their personal finances.
A sales commission draw is especially helpful to sales representatives who are still learning their jobs. They have a promised amount of income even when they aren’t earning large commissions.
The downsides of a draw on commission
Giving a draw against commission also has some downsides.
If an employee has several bad commission periods, they might not earn enough to cover their draws. The employee might accrue large debts to you. You might need a policy for cases when an employee owes you too much.
If an employee leaves your business and doesn’t have enough in commissions to pay their draws, you have to find another way to recover the money you paid the employee. You might be able to get the employee to pay the money back. Or, you might forgive the debt and take it as a loss.
Draw against commission laws
Commissioned employees typically must earn at least minimum wage. Make sure the draws you give your employees meet minimum wage laws.
Make sure you consult your state laws, as they might have stricter rules on draws against commissions.
When you create your business’s draw against commission policy, be sure to thoroughly look at federal and state laws. You might also consult an employment lawyer.
Pay your commissioned employees with Patriot’s payroll software. You can create multiple money types to pay employees draws and remaining commissions. Try the software for free.
This article has been updated from its original publication date of July 26, 2017.This is not intended as legal advice; for more information, please click here.