Recoverable and Non-Recoverable Draws
The path to becoming a successful B2B sales employee is paved with challenges. The average ramp time for an Account Executive is 4.9 months. It can take up to three years for a sales representative to reach peak performance, especially for businesses with long sale cycles.
Employers often subsidize the base salary of commission-based employees with draws. That ensures sales reps are paid fairly for their time and can continue their standard of living even if sales don’t go to plan.
Because of poor planning, businesses might miss an opportunity equal to 10% of their annual revenue.
A good sales compensation plan must motivate and support sales reps while providing a stable income. Draws are one of the ways employers can provide that stability.
What is a recoverable draw?
A recoverable draw is a way for employees to withdraw from their future commissions to maintain a more regular income.
For example, employee Xu is entitled to a recoverable draw of $1,000 per commission period. Xu earns $1,000 in commissions during that period and uses their full draw amount of $1,000 to take a total variable compensation payment of $2,000.
Next month, Xu earns $3,000 in sales commission and has to repay the $1,000 drawn from the previous period, so Xu still only takes home $2,000 that period.
If Xu only earned $2,500 in commission the next period, their employer will take collect the remaining $500 in the next pay period.
There are no set terms for recoverable draws. These are determined by the employer and laid out in the employee’s contract.
What is a non-recoverable draw?
A non-recoverable draw is a payment given to sales reps that the employer cannot or does not recover. Think of it as a guaranteed minimum commission payment.
If the total commission the employee earns that month is less than the draw amount, they are paid the difference. If the commission they earn that month is higher than the draw minimum, they receive it all but no draw.
For example, if the non-recoverable draw minimum for employee Ying is set at $2000, and the commission Ying earns that month is only $1,000, they will still be paid $2,000. If Ying makes $3,000 in commission next month, they will be paid the full $3,000 in commission but nothing from the draw.
Why offer a non-recoverable draw?
Non-recoverable draws have several benefits.
1. Both types of draw guarantee that salespeople will receive certain financial resources to cover their living expenses. Even though recoverable draws have to be returned, they act as an interest-free loan that can be repaid when they earn sufficient commission.
2. New sales employees might need time to generate revenue. Non-recoverable draws help sales employees cover living expenses until they earn sufficient commission to meet their expected OTE.
3. In some industries or markets, sales cycles can be more than 12 months long, and non-recoverable draws can help sales employees sustain themselves financially.
4. Non-recoverable draws are helpful when business and sales activity are affected due to economic events, a recession, strikes or disasters.
Do you pay tax on recoverable draws?
Employers provide recoverable draws as a loan that has to be returned. Draws that have been returned might not be taxable. However, non-recoverable draws which the employee keeps might constitute taxable income.
Do employees have to return recoverable draws?
Recoverable draws are essentially interest-free loans of future commission payments, which employees need to return. However, due to insufficient funds or other circumstances, some employees might not be able to return their recoverable draws. Employers should draft contracts that clearly explain the compensation structure and financial obligations of employees, and what protocol to take should an employee be unable to repay a draw.
If employees quit without reimbursing their employer, employers can legally recover draws if the law in their jurisdiction allows them to do so.
For example, in California, payments made by an employer to an employee constitute wages and cannot be recovered especially if the employment has ended. An employee’s future income can be deducted in California, but past payments cannot be recovered.
Even if employers have legal recourse, it might not be effective as the sales employee might not have sufficient financial resources. Also, pursuing legal action might affect reputation and employee morale. Companies may accept the cost and allow departing employees to keep the money.
Recoverable Draws Make Variable Income More Secure
57% of sales representatives might miss their annual sales target, and draws can help employees cover living expenses if sales don’t go to plan, providing them with similar financial security to a fixed salary employee.