What is a clawback in sales commission?
Clawbacks can seem like they penalize the individual, but this is not the case. It is important to know about clawback policies and find out how they work before signing an employment contract that includes them.
The post discusses what a clawback is and why companies use them in their employee’s contracts and incentive plans.
What is a clawback provision or policy?
Clawbacks are a commission payment that is repaid to a business for one or several reasons. The most commonly occur when a customer ends a contract earlier than expected.
Clawbacks are a sales commission payment that is repaid or taken back by the business.
Clawbacks are also used when a salesperson does something wrong, like overstating how much they sold, misselling a product, or doing something illegal.
Why do businesses use clawbacks?
There are several reasons that companies may choose to implement clawbacks in their commission structure.
1. Clawbacks protect the company
Salespeople are paid variable compensation based on the revenue they help generate (or at least that’s the idea). If that revenue isn’t generated, the business is at a loss. Clawbacks help protect the company from overpaying your sales team for bad sales practices or unforeseen changes of circumstance.
2. They encourage sales reps to retain customers
If customers routinely quit before their contract is up or don’t renew, the business stands to lose in the long run.
Clawbacks encourage sales reps to find customers who want to commit for the long haul and provide support during onboarding to ensure they get the most value from the product.
When do businesses use clawbacks?
Clawbacks are most often used when businesses want to protect revenue while incentivizing their reps to land accounts that they are confident will grow over time.
In that situation, companies must pay commissions before the customer pays their bill and value is realized after the customer implements or uses the product more, such as:
- Some subscription models
- when you operate a product-led growth model
- some usage-based pricing models
- deals that could fall through before full implementation
- contracts that are subject to legal clearance
Can companies clawback compensation if an employee commits a crime?
If an employee commits a crime or ‘acts unfaithfully,’ US companies often do not need to have a provision in their contract to claw back a payment.
Under The Faithless Servant Doctrine, which applies in many states, firms can attempt to recover money through the civil courts.
This is often easier said than done. Harvard Business Review points out that many large companies have failed to recover executive compensation in cases like the bonuses paid to Goldman Sachs executives involved in the 1MDB scandal or McDonald’s attempts to recover $40m from their former CEO.
Reasons to Be Careful with Clawbacks
1. They can be demotivating
If reps don’t understand the clawback or spend time worrying about whether it’s going to impact their income (or worse, shadow accounting!), then they’re likely to be demoralizing.
Communication is key here, and not just concerning why the clawback exists but also teaching them how to avoid it happening.
2. They can obscure visibility
Even the most clearly explained clawbacks introduce an element of complexity that reps will naturally try to account for during the sales process.
Too many types or clawback scenarios risk confusing and demoralizing your representatives and creating more sales commission disputes.
3. They’re an accounting nightmare
Commission clawbacks can be an accounting horror show, particularly for public companies that have to submit an ASC 606 and public earnings statements. Large clawbacks could force an earnings restatement and can make drawing useful insights from long-term forecasts challenging.
4. Some clawbacks are illegal
Even though the courts will side with an employer if an employee has broken the law, they will side with an employee if a clawback policy is designed to withhold payments or retroactively clawback sales compensation an employee rightfully earns, as in Oracle’s infamous $150 lawsuit over clawbacks. Some types of clawback may also be illegal in your jurisdiction, so check before you implement.
Use Clawbacks with Care and Clarity
Clawbacks are legal when part of an agreed sales compensation plan and are an acceptable way of protecting business revenue from misdeeds, mishaps, and missells. Sales representatives often have no problem with clawbacks as long as they are deemed fair and are clearly explained.
Involve your compensation board when setting a new clawback policy or designing your incentive plan, and make sure that you communicate why they exist and how to avoid them clearly to employees from their introduction.