Recoverable Draw vs. Non-Recoverable Draw
If you have ever been in a sales role, or played a part in a sales compensation program – then you most likely have heard the term “draw”. There are two main types of draws, recoverable and non-recoverable. There are two types because they accomplish different objectives and are processed differently. Depending on your objective, you can utilize draws to enhance your sales compensation program. Let’s get into it…
WHAT IS A RECOVERABLE DRAW?
A recoverable draw is cash that is paid to a sales employee that the Company will later recover from future sales incentive payments. The sales employee does have to pay back a recoverable draw. It is similar to an advance, where you advance payment to the employee for expected future commissions that the employee will generate.
WHAT IS A NON-RECOVERABLE DRAW?
A non-recoverable draw is cash that is paid to a sales employee that the Company does not recover from future sales incentive payments. This is also sometimes called a guarantee, or commission guarantee. The sales employee does not have to pay back a non-recoverable draw.
WHY IS A DRAW USED AND HOW LONG IS A DRAW FOR?
There are two main reasons companies use a recoverable or non-recoverable draw.
The first reason, and most common reason, is to help a sales employee ramp up. This is typically offered during the hiring process. For new hires, you pay the employee the draw until they are properly ramped up to fulfill the responsibilities of their role. The draw is typically paid in alignment with the timing of sales training, or sales enablement. The draw time frame typically ranges from 3 to 6 months, but again this time frame depends on your business and sales training.
This reasoning also applies to employee transitions or role changes. As an example, it could be a sales development representative moving into an account executive role. Since this is an internal employee, they have business understanding but training still needs to occur for the job responsibilities.
The idea is that you want the salesperson to focus on learning everything they need to excel in the role, without worrying about quotas or generating cash flow for their livelihood.
The second main reason for draws is to provide cash flow until an objective is met, such as contracts with very long sales cycles. As an example, if a sale takes 12 months to close, then that employee will not receive commission for the whole year. As a result, some companies elect to pay a recoverable draw throughout the year (monthly or quarterly), to provide cash flow. Once the contract closes the amount advanced in the recoverable draw is deducted from commissions due and the net amount is paid to the employee. Now, there are other ways to handle these types of sales without draws (such as paying commission based on key milestones), but this is just one of the ways it can be handled, through a recoverable draw.
HOW MUCH SHOULD A DRAW BE?
The amount typically offered for a recoverable or non-recoverable draw range from 75%-100% of their target variable, or target incentive, for the time period of the draw. The reason why some companies choose to offer a lower percentage, such as 75%, is because of the feasibility of quota achievement. If you think about it, even an experienced new salesperson will not achieve 100% of their quota, or objective, in their 1st month. However, for sake of simplicity and to encourage new employees, many companies still offer 100% of the employee’s target variable or commission for a specified time period.
The amount also varies based on the employee and type of draw. As an example, if an employee has to pay back the draw to the Company (i.e., it is a recoverable draw), then they may elect to choose a lower recoverable draw amount.
WHICH TYPE OF DRAW DO I USE – A RECOVERABLE OR NON-RECOVERABLE?
NEW HIRES
Typically, companies negotiate the type of draw with their new hires, whether its recoverable or non-recoverable. Generally, most companies offer a non-recoverable draw for new hires. They want to set the employee up for success and enable them to achieve objectives without worrying about paying back what they receive.
Of course there is the cost factor for draws, a non-recoverable draw is more expensive to a company compared to a recoverable draw. But in the end, the benefit of having a new employee focused on training and not worrying about future cash flow should pay off. With the right person in the right role, non-recoverable draws provide security and demonstrate to the employee that you value not just the sales they bring in, but their personal career and growth. You are making an investment in your new employee.
Some companies prefer offering a recoverable draw to employees to cover the risk of under achievement and to minimize sales incentive expense. It has happened, where a salesperson just collects the guarantee (i.e., non-recoverable draw) and does not produce any sales. The risk of non-performance is also related to the hiring process. Having the right people in the right role can mitigate the risk of non-performance. In addition, if the person is a good fit for the role, they will cover the cost of the guarantee (i.e., non-recoverable draw) because they are driven to exceed. Our general recommendation, to be competitive in today’s market, is to offer non-recoverable draws for new hires.
INTERNAL TRANSFERS
For internal transfers, it’s rare for a company to offer a draw, but if they do, they typically choose a recoverable draw. Since the existing employee already has company knowledge and training should not take as long. Because of this, the draw can also be for a shorter time period and on a decreasing scale.
RECOVERABLE AND NON-RECOVERABLE DRAW AGREEMENT
Usually when a draw is provided to an employee there is a written document. That document should specify key items, such as: the time period for the draw, the amount paid per period, the timing of payment, terms in case of separation, etc. Most recoverable & non recoverable draw terms are embedded in a new hire offer letter, since they are typically offered during the interview process. However, in the case where it’s used for roles that are transitioning or other circumstances, you should document these terms and have the document duly signed. NOTE: We are not providing legal advice, just our experience managing these matters. Always check with an attorney for all legal matters.
HOW DOES A DRAW WORK AGAINST COMMISSION?
Whether a draw is non-recoverable or recoverable, the amount specified for the draw is the minimum amount for the draw period and factors in commission. Let’s go through an example…
- Let’s say a company offers a recoverable draw of $3,000 for Q1. The new employee is able to generate $1,000 in commission. The amount paid to the employee is $3,000 ($2,000 R-draw + $1,000 commission). The amount the employee has to pay back is $2,000.
- Let’s say a company offers a non-recoverable draw of $3,000 for Q1. The new employee is able to generate $1,000 in commission. The amount paid to the employee is $3,000 ($2,000 NR-draw + $1,000 commission). The employee does not have to pay back the non-recoverable draw.
Both a recoverable & non-recoverable draw against commission have to be tracked and managed, because there is a signed agreement that can be enforced. To save a company time, and to give better understanding, we have created a recoverable and non-recoverable draw example template that companies can use. This is just one of the resources we have in our sales compensation community. You can join our professional sales comp community today and download for free. Our goal at Sales Comp Academy is to educate businesses so that they can have the best sales compensation program.
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