SaaS Sales

SaaS Sales Commission Calculator for Long Term Contracts

Since my post entitled SaaS Sales Compensation Made Easy, I’ve received a number of inquires about how to adjust SaaS sales commission percentages for very short and very long term subscription contracts, e.g., renewal periods of 1 month vs. 2 years. Clearly a 2 year contract paid in advance is worth more than a monthly renewal and should pay a higher commission. But, how much more?

In the model, I propose as best practice that SaaS sales commissions should be paid 100% up-front in proportion to the lifetime value of the sale (LTV). But to keep things simple, recurring revenue (ARR, QRR, or MRR) is substituted as the everyday measure of LTV, because LTV is always directly proportionate to recurring revenue. Basically, pay on recurring revenue in SaaS just like you would pay on price for any other product. It’s that simple….provided: 1) contract terms don’t vary widely and 2) the churn rate is uniform across customers (no churn cohorts).

However, adjusting your SaaS sales commission plan for these two factors isn’t complicated. You can do the LTV math in the background to produce a simple table of adjustments to the baseline SaaS sales commission for each contract term and/or churn cohort. Then, include this simple table of adjustments in your SaaS sales commission plan. The spreadsheet below does exactly this. (you can “Click to Edit” and play with the numbers or download to Excel. Go ZOHO!).

This enhanced SaaS sales commission model incorporates the effect of payment terms
and churn on lifetime value. The top table adjusts for contract term only,
whereas the bottom table allows for churn cohorts as well.

From the previous SaaS sales commission model post, we know that the lifetime value of a SaaS sale comprised of recurring subscription payments made in advance is given by the following formula:

SaaS Subscription Sale LTV = recurring payment x ( 1 + i )
i + a

i = cost of capital; a = churn rate

It is evident from this formula that if either contract term (i) or churn (a) vary across a wide range, then the calculation of the SaaS sales commission based on LTV should be adjusted accordingly (see LTV notes in the spreadsheet for the impact of contract term on i ). Put simply, if your contract terms (renewal periods) vary from monthly to every 2 years, you should consider adding a premium to the SaaS sales commission for 2 year contracts and a discount to the SaaS sales commission for monthly contracts. Or, if monthly customers cancel much more frequently than annual customers, say at a churn rate of 20% for monthly compared to a churn rate of 5% for annual, then you should again discount the SaaS sales commission paid on monthly contracts.

Using the formula above, the spreadsheet calculates a table with the commission percentage for each contract term and churn cohort. This table is created by taking the baseline commission percentage and multiplying it by the ratio of the LTV for each scenario to the baseline LTV. In the spreadsheet, an annual contract is used as the baseline.

To calculate the adjusted SaaS sales commission table that is right for your SaaS business, start by entering the target quota and target commission at quota to generate the baseline commission percentage. Then, you must select a cost of capital that reflects how much your SaaS business values cash up front. The more you value cash up front, the higher the number you put in for cost of capital. For a rapidly growing venture-funded startup, the cost of capital can be well in excess of 25%.

If your SaaS business experiences dramatically different cancellation rates by contract term, then you should adjust the churn rate for each contract term using the second table at the bottom. You can also use the spreadsheet to create adjusted SaaS sales commission tables for two different churn cohorts by entering one churn rate for the top table and a second churn rate that is the same for all contract terms in the bottom table.

It is also instructive to type in a value of 100% churn, implying that contracts are never renewed. In this case the SaaS sales comission payout is 1/12X, 1/4X, 1X, 2X, 3X for monthly, quarterly, annual, 2 year and 3 year contract terms respectively. This is the source of SaaS Sales Compensation Mistake #1 – Paying SaaS Sales Commission on Explicit Total Contract Value. Unless your churn rate is 100% or your cost of capital is infinite, you should not pay SaaS sales commissions based on total contract value. Over time, an automatically renewing annual contract will bring in exactly the same amount of money as a three year contract (provided the churn rate is the same). The only difference is the interest you can earn (or save) on the money up front, which is represented by the cost of capital.

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18 Comments

  • Sure Rick,

    The motivation for this spreadsheet is very much a result of the requests for more concrete examples of paying on lifetime value that came out of the LinkedIn discussion with Jeff and yourself.

    While I am at it, I should certainly include Philippe Botteri over at Bessemer Venture Partners as well. And, I highly recommend his post on SaaS Sales comp for additional examples.

    My contribution is strictly limited to formalizing the method to the madness by highlighting the overriding principle of paying up-front in proportion to lifetime value along with the mathematics required to implement it (and I wouldn’t claim that as remotely original).

    Cheers,

    Joel

  • Joel,

    Hi – thank you for documenting this – it’s very helpful. I do have one additional question if you don’t mind and that is; do you have any thoughts as to how professional services should be included in a SaaS comp plan? We often have to sell services as part of our solution and whilst we want to be focused on ARR we obviously cannot remove the services element completely. Our current thinking is to use a flat % rate (capped) and not have quota/OTE. I would appreciate any thoughts/comments you have..

    thank you in advance
    Andrew

  • Hello,

    Thank you for this great post.

    One thing is not clear to me – from the example above, where there is an initial sales of $12,000 in ARR. How come the sale LTV is around $37K monthly and $42K annually ? Also, if I reduce the capital cost to %1(never mind why) the sale LTV crosses $100,000… something doesn’t make sense for me… how come it reaches these numbers ?

    Thanks,
    David.

    • Hi David,

      You can see the actual formulas by clicking on the tab “LTV notes” for a detailed explanation. But, the gist is as follows

      • The LTV of the annual payment contract is higher than that of the monthly, because payment is assumed to be in advance. Therefore, more money is received earlier in the annual plan, i.e., 12 months up front at the beginning of each year instead of dribbling in every month over the course of the year.
      • If you reduce the capital cost to zero, it implies that there is no time value to money, i.e., a dollar tomorrow is worth the same as a dollar today. In this case, the LTV is simply the sum of cash received over time or payment / a where “a” is the churn rate. Often 1/a is quoted as the “average lifetime” of customer, so that the LTV = payment x average lifetime, or rather the total cash received from the customer during an average lifetime. In the example, the churn rate is 10% giving an average lifetime of 10 years. 10 years of payments of 12K ARR gives an LTV of 120K (or, your value of 100K for a small time value of money of 1%)

      Hope this helps.

      JY

  • Hello Joel,

    Thank you for the reply. It is clear now… I didn’t see the 10 years time factor.

    One more question if I may :
    In my case, we are a SaaS company that sells a very unique solution for the financial sector. We have a clear model where we sell ONLY through channels/VARs. We have ZERO marketing cost since all of the work is being managed by our VARs that we trust well. We have only “farmers” that nurture and manage existing sales and heavy clients, including the relationship with our VARs. We do very well in our domain for the last two years.
    Typically VAR signs $5,000 CMRR subscription deals, recurring every month. We have about %15 churn and COGS %30.
    We give our VARs $2 bonus for NEW CMRR. No Quota – if you sell it – you get the money. Our VARs are fine with it. for every new contract they get $10,000 distributed over 4 months to make sure they are involved and active and also to avoid churn.
    From our perspective the CAC ratio is still very good because we pay it back fully in several months.
    We have a big dilemma on what is the right way to compensate the VARs. The situation is that our VARs truly say that they have all the sales cost and therefore they want higher commission($3 Bonus on $1 CMRR). It makes sense because our CAC is still very high but on the other hand I can see that usually the ratio between CMRR to the annual sales is about %8-10.
    Do you have any thoughts or suggestions in this scenario ? Any comment will help since I truly appreciate your work :))

    Thanks,
    David.

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  • I need a software sales spreadsheet to include a sliding scale…wherein month one I would receive a nice bump, then as months continue on the clients’ subscriptions, the amount would decrease, then eventually even out month to month, hopefully in perpetuity…that is, as long as I maintained the client and they re-signed with us after their initial contract terminated.

    I already pitched your (very solid) idea of paying me a flat percentage, that is, ALL the commish, right up front. It was shot down.

    I’m no Excel expert…by choice! I sell stuff for a living. I can operate a spreadsheet and noodle out it’s inherent meaning and use. This is admitedlly different from what I’m used to. Employers typically to provide contracts and commission schedules; but this is a start up and they felt I should design my own comp plan as a 1099…! Can you PLEASE help me out? I’m supposed to begin work here very soon and I can’t even start without a solid base/understanding and clear agreements on how I’m to be compensated.

  • Trying to access quota calculation for figuring out commisions.
    Your download calculater not working.

    Thanks,
    Shawn

  • Hi Joel,

    Can you explain the difference between Quota in ARR vs Actual Sales in ARR? For example, if I want a sales rep to sell $120,000 annually, would Quota in ARR and Actual Sales in ARR both be $120,000?

    I must be missing something.

    Thanks.

    • Hi Michael,

      Quota in ARR is what you would like the rep to achieve in the given period, i.e., the goal.
      Actual Sales in ARR is what the rep actually achieves, i.e., the result.
      Achievement relative to the goal determines the ultimate compensation.

      Cheers,
      Joel

  • Hi,

    I think cell A6 in the spreadsheet should be “Actual Sale in RR”.
    This RR will go hand in hand with cell A2, which could be MRR, QRR, or ARR.

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