A comprehensive guide to commission-based pay: Examples & best practices

It’s rare to find a sales rep that doesn’t earn some kind of commission.  

Especially for experienced reps at larger organizations, a strong commission rate is a powerful financial incentive to motivate your sales team and retain top talent.  

However, complexity is common from both the planning and the administration side of commission-based pay.  

Besides needing to create sales compensation plans generally, you need to decide on many variable factors in your sales performance management strategy. I.e.:

• What is the ideal pay mix ratio for the way your sales team's structured/roles in play?  

• What do you need to remain compliant with pay and labor laws?  

• And critically: do you have the commission payment software and internal processes to manage fluctuating paychecks on a determined cadence?

This article shares some considerations, with guidance on how to approach commission-based pay and best practices to keep in mind.

First though: What is commission-based pay?

Commission-based pay is a compensation structure where sales reps earn a portion of their income as commission on sales they make. This commission can either determine their entire pay packet, or it can be delivered as an extra incentive on top of their base salary.  

Either way, the commission acts as an extra financial incentive for reps to meet and exceed their performance targets.

No matter the sales commission structure you end up choosing, the pay mix ratio (the balance between base salary and commission) can vary dramatically on your business model, market competitiveness, and rep preferences.  

• Organizations looking to recruit experienced reps might need to offer a lower base salary and higher commission. (High performers are often highly financially driven and thrive on uncapped commission earnings).  

• Similarly, hunter sales roles might prefer a higher commission structure because it’s their job to seek new deals.  

• Farmer roles managing and expanding the existing customer base, may be better suited to a higher base salary and less opportunity for commission.

What's the difference between commission and bonus?

Commission awards reps with a percentage of the total sales volume. Bonuses, however, are short-term financial incentives that reward reps when they meet certain goals. Reps can be on 2% commission and earn a $500 bonus if they close 10 new accounts in the next month, for example.

So, how is commission calculated?

Typically, sales commission is calculated based on the percentage of the revenue that's generated by a salesperson’s sales. The exact method varies depending on the company's exact compensation plan as we'll get into in the structure examples below.

Sometimes companies offer sales reps tools via their incentive compensation management platforms to calculate commission, though we advocate for a more comprehensive approach.  

Before diving into the example structures, let's quickly explore the benefits.

Strategic commission-based pay can help combat turnover

Unlike employees receiving a stable paycheck month to month, the ability to maximize earnings based on performance is a key motivator for sales reps. Some 74% of salespeople said their primary career motivation is money.

Failing to offer substantial financial rewards for their effort risks turnover: A recent report unveiled that uncompetitive pay and/or benefits is a deciding reason for reps who are considering a job change. Around two-thirds of reps would leave if they were offered a similar job elsewhere with better pay.  

Turnover is a costly problem for sales organizations. It costs the equivalent of six to nine months of the average employee’s salary to replace and recover from this attrition. This ultimately ends up becoming a bigger expense than offering commission-based pay to begin with.  

The 8 types of commission-based pay structures (with examples)

Ok, now let's dive into some of the most common types of sales commission structures and how they work.  

Below are the different commission models to consider when building out your incentive compensation plans, including tiered, residual, territory-based, or draw-based commission.  

1. Straight commission (or commission only)

This one's pure adrenaline, no safety net. In a straight commission structure, reps only earn commission with no base salary. Monthly income fluctuates, and there’s no guaranteed minimum earning—but equally, no maximum. Commission here is completely down to sales performance, which presents administration challenges for certain employers as payouts are constantly changing.

Straight commission tends to be a flat percentage of the sale value—like 5% of the total sale being paid as commission.

For example, if a rep sold a $19,000 deal, they’d be entitled to an extra $950 on their next paycheck.

2. Base salary plus commission

This is the bread-and-butter commission structure: a mix of steady, reliable income with extra pending how well you perform. With this commission structure, reps earn a guaranteed base salary and commission on sales above quota. You can think of this one as stability meets motivation—no more worrying about paying rent, while every closed contract is extra money in the bank.

For example: a rep might earn a base salary of $60,000 per year plus 6% commission on all sales they generate. If they make $250,000 in sales, their compensation would be $60,000 (base salary) plus $15,000 in commission, making their total earnings $75,000.  

Potential drawbacks:

• Can leave high-flyers craving more—flat commission rates can cap their drive.

• Disputes can crop up when terms like discounts or refunds muddy the waters.

3. Gross-margin commission

Commission can also be calculated from the gross margin of the customer’s order. Gross margin commission shifts the focus from top-line revenue to bottom-line profitability. Instead of rewarding reps solely for closing deals, this model doles out commissions based on how profitable each sale is. In this scenario, one $50,000 sale might not be equal to a similar $50,000 sale—it’s all about the margin.

For example: If a rep sells a $20,000 deal, if the cost of goods sold (including a portion of the rep’s base salary, time given on a product demo, and digital signature software) totals $6000, the gross margin would be $14,000. Two percent of this figure would be $280, which the rep takes as commission.

Potential drawbacks:

• This structure can be a bit unpredictable for reps—commission becomes more complicated than a straight-up percentage.

• Requires more behind-the-scenes math.

4. Tiered commission

Ah, tiered commission—where the thrill of the chase kicks in. A tiered commission structure means that with each deal, reps inch closer to a bigger payday. As reps climb the ladder toward their sales quota, their commission rate increases at certain milestones. The closer they get to 100%, the more cash they pocket.

For example, you might offer 1% commission for <75% quota attainment, 2% for 76-99%, and so forth. This motivates top performers to reach ambitious goals since the financial reward increases in-line with performance.  

Potential drawbacks:

• There’s a risk of short-term thinking, with reps hyper-focused on hitting the next tier.

• Some reps may hold back deals for the next cycle to hit higher commission brackets. (Check out this piece to discover how you can build plans that are more difficult to exploit.)

5. Variable commission

When you’ve got a complex product portfolio across multiple regions, this structure becomes a game-changer. You want reps laser-focused on key products or markets? This model dials up the reward where it counts and dials it down where it doesn’t.

In the variable commission structure, different products or regions carry different commission rates. Shiny new products might have sky-high rates, while legacy products have lower percentages. The same goes for high-growth markets/territories—boost the incentive there and watch your reps flock to them. The overall benefit of this approach is that it's like giving your sales team a treasure map—X marks the most profitable spots.

As an example of this structure: A rep could earn 6% commission on the latest product but only 3% on a legacy-feature upgrade. They’ll naturally focus on pushing the hot new item, while still keeping some legacy deals ticking over.

Potential drawbacks:

• Not for the faint of heart—this structure is a bit more complex to manage.

• Some products may get neglected, even when they’re still important. (learn how our compensation expert's suggest balancing multiple sales objectives in multi-product bags)

6. Residual commission

You can think of this one as the gift that keeps on giving. Once a deal is closed, a rep continues to earn commission on that customer for as long as revenue flows in.  

With a residual commission structure, reps earn commission not just when a new customer signs, but also when they renew their contract or have a subscription payment processed.  

Residual commission is best suited to businesses that have goals around customer retention or increasing customer lifetime value. The lure of recurring commissions means reps are incentivized to find customers with longevity, as opposed to earning a higher one-off commission with no regard for whether the customer will drive substantial revenue in the long term.

For example: A software company might incentivize reps with 0.5% residual commission for the lifetime of each customer, instead of a flat-rate of 1% that becomes payable a month after the customer pays their first invoice.

Potential drawbacks:

• Losing a large customer can be a massive blow to ARR, the quarterly goal, and ultimately earnings.

• This model typically is best suited for subscription-based industries or businesses with ongoing revenue streams.

7. Multiplier commission

Ever feel like your commission rate could use a turbo boost? Well, this is what multiplier commission is for. This structure rewards reps who go above and beyond—selling add-ons, upselling on features, or hitting multi-product sales goals which can multiply their commission exponentially.  

With this commission structure a rep’s commission rate gets multiplied if they hit certain targets—like selling complementary products or upselling during the same sales period. Reps push for bigger, better deals, making the most of every opportunity.

For example: An account executive makes a $100,000 sale with a 5% commission rate. But they also manage to sell five units of an add-on service. Now, their commission rate multiplies to double, giving them a 10% payout across the board for the additional. That is double the amount of commission – $10,000 instead of $5,000.

Potential drawbacks:

• It can get a bit tricky to track all those multipliers.

• Not every deal may be ripe for an upsell—some reps may struggle to hit the secondary targets.

8. Territory or team-based commission

Commission doesn’t just have to be awarded on an individual basis. Reps working within the same territory or sales team can share commission, provided they meet the team-wide quota or sales target.  

A business that’s looking to increase market share in a particular sales territory, for example, could incentivize reps with 20% commission on all sales—a figure which increases in-line with market share advancements. This collective approach fosters a sense of teamwork and collaboration. Reps feel responsible for the performance of their territory and have a sense of ownership. Everyone has to work together to earn commission.  

How to choose the right commission-based pay structure for your business

There’s a wide range of commission packages because not all companies and reps respond to a single one.  

To choose the best commission-based pay structure for your sales organization, consider the following factors:

• Business goals. Commission should incentivize behaviors that align with your overarching goals. An organization that wants to reduce customer churn, for example, might award residual commission on every subscription sold, whereas a business with a goal to increase profitability might award commission on the total profit earned per sale.  

• Sales cycle length. Businesses with a long sales cycle might be better suited to a commission-based model that awards them a portion of their total commission at each stage. For example, of their 2% total commission, reps could earn a quarter when a demo is complete or a contract is signed. This keeps them motivated to work leads because the financial reward isn’t delayed by months.  

• Market or territory conditions. Reps operating in lucrative territories might find it easier to close deals, meaning they rake in commissions. Reps assigned to less lucrative territories can be envious of this. They have to work much harder to earn the same pay.

• Industry norms. Commission rates vary dramatically based on the industry you’re operating within. Per Mailshake, sales reps in the architecture space tend to have the highest average commission rate at 37% per sale. Real estate falls at the bottom of the ranking with reps earning around 28% commission.

• Rep preferences. The preferred split between base pay and variable commission varies by rep. Financially driven and risk-tolerant reps might prefer a 75/25 split that skews toward variable commission, whereas reps with young families or breadwinners in their household might prefer a 60/40 split with a higher guaranteed base salary and less risk of fluctuating commission.  

Commission-based pay and its legal considerations

Commission-based pay is legal in the United States, but there are several considerations to ensure compliance with labor laws.

Major legal pitfalls to avoid when designing a commission plan include:

• Minimum wage requirements. You must make sure that your on-target earnings (including commissions) meet or exceed the federal minimum wage. In the U.S., this is $7.25 per hour for nonexempt employees.
  

• Overtime. The Fair Labor Standards Act (FLSA) requires that employees who work more than 40 hours per week are paid overtime. In the case of commission, however, reps may be exempt under Section 7(i) provided more than 50% of their total earnings are commission-based, and the regular rate of pay is more than 1.5x the minimum wage for each overtime hour.  
  

• Deductions. You’re responsible for deducting federal/state income taxes, social security, and Medicare taxes from W-2 employees’ paycheck. Commissions are usually liable for federal taxes, usually at a flat rate of 22%, as well as social security at 6.2% and Medicare at 1.45%.
  

• Fair compensation rules. Per the FLSA, employees should receive equal pay for jobs that are equal in effort, skill, and responsibility—including any commission on offer. Work with HR to set fair and equitable targets for reps with different quotas and territory assignments.

“The cost of not being compliant has significant consequences,” says Forma.ai’s CEO and Founder, Nabeil Alazzam:  

“A rollout of a comp plan is different by country, by geo. Even within the same country, across states, it’s going to have different requirements. And if you missed that, there’s some significant consequences, especially when you think about the cost of the investment that’s made in this space."

The critical sales commission agreement

You’ll need a legally sound sales commission agreement for every rep that’s earning commission—even if it only forms a small part of their compensation package. It protects your business against disputes and sets clear expectations and metrics for success.  

Enlist the help of a legal expert to draft a sales commission agreement that you can personalize for each rep.  

Generally speaking, this official document should cover:

• The commission a rep is entitled to and how payouts are calculated  

• Sales targets or performance goals they must meet before being entitled to commission  

• Payment timelines—i.e. when they’ll be paid eligible commission, such as four weeks after the deal closes to account for your customer returns period

• Clawback provisions that allow you to revoke commissions (e.g. if a customer requests a refund)

• What to do in the event of a commission-related dispute  

Best practices for effectively managing commission-based employees

1. Implement spiffs and bonuses for short-term targets

Sales performance incentive funds (spiffs)—bonuses reps earn for meeting short-term targets—can be combined with commission-based pay structures to incentivize specific goals.  

If you’re introducing a new product, for example, you might offer a spiff that rewards people with a $1,000 bonus if their team sells $100,000 worth of the product. Reps still earn 2% commission on sales above quota, while the spiff acts as an extra push to collaborate with the team and meet another goal.  

Spiffs can also help with performance. If low-performers are falling behind on quota attainment, for example, you might offer a spiff of a $150 bonus if they bring in an extra $1,000 by the end of the quarter. They don’t earn the commission on offer since they’re below quota, but they still have a financial incentive to push forth.  

However, HubSpot’s Senior Manager of Compensation, Incentives Strategy, and Operations Kat Walenty warns against over reliance on constantly changing short-term incentives:  

2. Consider commission clawbacks

A clawback is a provision that lets you withdraw commissions if a sale falls through. If a customer returns their product or cancels their subscription, for example, you can claw back the commission to avoid paying out a percentage of revenue that the business has not actually received.  

Clawbacks can also be used to deter reps from unethical behavior. If a rep has overstated how much they’ve earned or miss-sold a product that isn’t in a customer’s best interest to earn a higher commission payout, for example, a clawback provision allows you to claim earnings back.  

The downside to clawbacks is that they’re a reporting headache. There’s also gray area around clawbacks, with some provisions only allowed in particular jurisdictions. Investing time into creating a watertight commission agreement that includes a clawback provision can protect your organization from skewing the balance off and rewarding unethical behavior.  

3. Avoid commission caps

You’re not alone if the thought of offering unlimited income potential makes you feel uneasy. However, putting a ceiling on commission can deter reps from achieving their full potential and pushing to meet ambitious goals.

As Justin Lane shares:

Remember that commissions are only paid when the rep brings in revenue. While unrealistic, uncapped commission theoretically means your payroll could run into the millions—but you’ll only have that outlay when reps bring in multiples of the same figure in revenue.  

4. Be transparent around commission structures

Commission-based pay structures shouldn’t be a one size fits all approach. The commission you’re offering can vary by rep, team, and territory. What’s important is that you’re transparent with how this works and why it might differ.

Say that you’re offering reps within your Louisiana territory 2% commission on all sales. Those in your New York territory team, however, only earn 1.5% because opportunities in this region are more plentiful. Deals are also easier to close in New York since your brand already has some existing recognition within the state.  

You’ve asked reps to keep their commission percentages confidential, but in a private Slack conversation, your Louisiana sales team member mentions that they earn more commission than the unknowing New York rep. Your NYC rep may come to you confused and angry, demanding to know why.  

Transparency can avoid this. By clearly outlining how commission structures are calculated and explaining why some territories have higher commission percentages than others, nobody feels out of the loop.  

Using commission payment software (and going beyond automating payouts)

Because a commission-based pay structure means that the total amount each rep receives in their paycheck fluctuates, administration of payroll naturally becomes more complex to manage.  

Incentive compensation management software (ICM), commissions software, or (the broader) Sales performance management software are powerful tools for managing this complexity.  

With these types of platforms in place (pending the capabilities and robustness of the solution you opt for), you can:

• Outline, plan, and manage sales territories

• Set fair quotas based on historical data  

• Forecast the impact of various changes to a compensation plan with modeling or simulations  

• Show real-time sales compensation dashboards to help reps course-correct if they’re not predicted to make their OTE  

• See performance insights and reporting

Plus, with a full-stack SPM platform like Forma.ai, you’ll create one single source of unified sales performance data across your organization. Besides unifying all of your data for territories, quotas, incentives, from their various data sources (we integrate with 200+ data sources natively) you'll be able to plan and execute all of your sales performance management in one location. Along with easy payouts as there are no manual calculations required on your part.

Frequently asked questions about commission-based pay

What is a typical commission rate? Is there an average sales commission percentage?

There is no “typical” commission rate—it depends on the industry, company goals, profit margins, and the individual rep. High performing reps might prefer a 10% commission rate and lower base salary, whereas new or less experienced reps might settle for 2% commission and a higher base salary for extra financial security.

Why is commission-based pay good?

Commission-based pay gives reps a financial incentive to meet or exceed their performance targets. It also gives companies greater flexibility. Instead of paying out a fixed base salary each month that stays the same (regardless of sales performance), commission is only paid when reps bring in sales.

How is a commission paid?

Sales performance management software can track revenue and attribute sales to a particular rep or territory. Forma.ai can compare this data to their compensation plans and accurately calculate how much commission is payable.