Draw against commission: What it is and how it works

What is a draw against commission?

A draw-against commission (DAC) payment structure guarantees employees a minimum income per pay period. In other words, it’s a sales compensation plan that provides an advance or loan to employees that is subtracted from their future commissions.

The concept has some similarities with a cash advance. You pay your sales reps a fixed amount upfront — and they “pay back” the fronted money using future commissions. The upfront payments are taxable income and must adhere to payroll tax regulations.

How does a draw against commission work?

A draw against commission begins with an advance payment to a salesperson. For illustrative purposes, let’s assume an employee is advanced a recoverable draw of $5,000 each month. Further, let’s assume this same employee earns $4,500 in commissions for the month. Given the shortfall, the company will withhold the $500 from future commissions earned by the employee.

Now that we better understand the basics, let’s learn about the most common ways employers set these up.

Types of draws against commission

Simply put, there are two types of draws against commission: recoverable draws and non-recoverable draws.

Recoverable draws

A recoverable draw against commission is characterized by the fact the sales representative must pay back the draw. This arrangement is similar to a loan from the employer. If an employee’s commission isn’t enough to cover the draw, the shortfall is carried over and withheld from commissions earned in subsequent months. This is the most common type of DAC.

Recoverable draw example:

• Monthly employee draw amount: $5,000
• Monthly commission employee has earned: $4,500
• The $500 shortfall is carried over to the next month
• If the next month’s commission is $5,800, the current month’s $5,000 draw and the prior month’s $500 shortfall will be settled in full
• This leaves leaves the employee with an excess of $300 ($5,800 – $5,000 – $500).

Non-recoverable draws

A non-recoverable draw against commission is characterized by the fact the sales representative does not have to pay back the draw. If an employee’s commission isn’t enough to cover the draw amount, the employer forgives the shortfall.

Non-recoverable draw example:

• Monthly employee draw amount: $5,000
• Monthly commission employee has earned: $4,500
• The shortfall of $500 is not carried over to the next month
• Here the employee keeps their full commission in subsequent months

Moving on, let’s find out about the potential pros and cons of using a DAC.

Benefits of draws against commission

There are several reasons employers use a DAC. Below is a list of the most prominent benefits.

Providing financial stability

Draws against commission provide financial stability for employees in industries where sales can be unpredictable. Employees get a consistent guaranteed paycheck, even during slow months.

Encouraging high-risk, high-reward opportunities

DACs can encourage employees to pursue high-risk, high-reward opportunities. When they have a guaranteed paycheck, salespeople may feel more comfortable attempting to close ambitious sales prospects. This can lead to increased revenue and greater growth for the company.

Enhancing sales performance

This methodology can motivate your sales teams to perform better. At the end of the day, commissioned employees make more money when they close more deals. Moreover, when employees must pay back any shortfalls they accrue, this can motivate them to work harder to avoid racking up large debts.

Supporting new hires

A DAC helps new hires concentrate on building their pipeline without worrying about where their next paycheck will come from. It provides a sense of security, allowing your reps to concentrate on their new roles. Offering draws against commission can also help attract top sales talent. DACs may entice them to join your team.

Drawbacks of draws against commission

The benefits of a DAC program are clear, but this type of framework also has some potential drawbacks we need to touch on.

Potential dependency on draws

While DAC programs can provide stability for sales representatives, they might also cause some employees to rely too heavily on the guaranteed paycheck. If workers know they will receive their draw no matter what, it could result in the lack of motivation necessary to meet sales goals. This risk is greatest with a non-recoverable draw program, where employees aren’t required to pay back advances, if sales fall short.

Cost implications for companies

Under a traditional commission system, salespeople are only paid when they make a sale. However, with a DAC program, salespeople are paid in advance, even if they haven’t made any sales. This means the company is investing in their employees upfront, but they might not always earn that money back. If salespeople continually fail to meet their sales goals, it can cause financial problems for the company.

Impact on commission motivation

When employees view their draw as guaranteed income, they may not be as motivated to exceed their sales targets. Since they know they will get a draw regardless of how they perform, some employees may not put in as much effort as they would if they were on a regular commission-based system.

At this point, you’re likely thinking a DAC could have a fit your company’s needs, so let’s talk about how some employers put these in place.

Setting up draw against commission programs

Implementing a DAC program entails careful planning. Embracing the guidance below can help you successfully establish a compensation structure that works for your organization.

Strategic planning

Strategic planning enables an organization to formulate a roadmap of goals and contingencies, which foster an achievement-oriented culture and can facilitate greater collaboration amongst your employees. On the DAC program front, start by figuring out how much the draw should be, ensuring that it gives employees adequate financial support, but is also economically sustainable for your company.

Next, set clear goals and performance measures that clearly articulate  exactly what employees need to do to succeed. A well-designed DAC program can help keep employees motivated and propel your business forward.

Aligning with organizational goals

Remember, your DAC program should align with your organization’s overarching goals and plans. Strive to implement a DAC program that supports your company’s strategic business strategies. Doing this helps ensure your employees have a shared understanding and focus their efforts on the things that matter most.

Automation and software support

Utilizing automation and software support can help streamline the DAC process, making it easier to manage and track DAC payouts. Payroll tools can ensure precise calculations of draw balances, repayment amounts, payroll deductions, and final commission payouts.

Importance of transparency

There should be no surprises when it comes to a DAC program. Your employees need to clearly understand how it works, their sales goals, and the type of draw you offer. Being open and honest about these details can reduce confusion and help employees stay motivated and productive.