Simple Math to Set Up a Sales Team
Let’s say you’re a SaaS founder who’s looking to build a sales team for the first time. How do you structure quotas and compensation for the initial sales reps and their manager? Oftentimes, the biggest hurdle in hiring the first sales rep is not knowing how to incentivize them. This post provides simple rules that you can use to set up a sales team. Structured properly, the process is surprisingly mathematical.
Let’s start with the sales plan for an individual sales rep, or “account executive” (AE). The key elements of an AE sales plan are:
- Base Salary;
- Commission Rate;
- Variable Pay (Quota times Commission Rate); and
- OTE (“on-target earnings”), the sum of the AE’s Base Salary and Variable Pay.
This sounds like a lot of variables, but two industry standards allow us to simplify greatly:
- The standard commission rate for SaaS products is 10%. For example, closing a $100,000 ARR deal generates a $10,000 commission.
- In constructing an OTE for an AE, a 50/50 split between base and variable compensation is typical. For an AE who’s hitting quota, their variable pay will equal their base salary.
Taken together, these standards generate a third rule: the typical quota will equal 10x base salary. I call this the Rule of 10. This generates the following pay scale for AEs:
For simplicity, I’ve presented annual numbers, but quarterly sales plans are actually ideal. (I explain why in The Cadence.) Just divide the numbers by 4 to put your AEs on a quarterly plan.
Once an AE hits quota in a quarter, their commission rate should increase to 15% on incremental sales. This “accelerator” incentivizes the best AEs to keep pushing past their target, instead of slowing down at a perceived finish line.
For new AEs, the industry-standard time to hit productivity is 4 months, but this can be longer or shorter depending on how long it takes to learn the product and develop a pipeline. Most sales orgs set a ramping schedule, during which time new AEs have a lower quota and higher guaranteed comp (known as a “draw”) to make up for lack of commission. For example, a 50% draw would mean that the AE is granted half their variable comp for a quarter. If an AE is still not productive after 2 quarters, you may need to let them go or put them on a performance improvement plan.
It’s better for all AEs at the same level to be on the same plan. One-off promotions or raises can become a slippery slope. That said, if an AE consistently exceeds quota, the Rule of 10 provides a basis for giving them a raise. For example, if an AE reliably generates $600k in new ARR, then it’s fine to increase their base salary to $60k. However, their quota would now need to increase from $500k to $600k. Be careful to avoid raises that turn a successful AE who’s hitting quota into an underperforming AE who’s missing quota.
“Quota Capacity” (QC) refers to the total team quota. For example, if you have 10 AEs with quotas of $500k each, the team’s quota capacity will be $5 million. If you are forecasting $5 million in new ARR for next year, but have only 2 AEs ramped ($1M of quota capacity), you are very unlikely to hit your goal. Hence the value of the QC concept.
The average team attains about 70% of their QC, so some over-capacity is needed to hit your goal. In planning, make sure you also allow enough time for new AEs to ramp.
A manager’s quota should be set at 80% of their team’s QC. The manager’s OTE (also 50/50 between base and variable) will be set by market rates for a manager, director, or VP in their position. Commission rate will be the dependent variable. For example:
- Let’s assume a manager of 10 junior AEs ($5M QC) makes $200k OTE.
- $200k OTE means $100k base and $100k variable.
- 80% of quota would be $4M New ARR.
- Their commission rate at $4M New ARR needs to generate $100k of variable.
- Therefore, their commission rate is $100k/$4M = 2.5%.
If the team is hitting over 80% of QC, that’s a sign you can hire more AEs. In fact, anything above 70% could warrant additional hiring as long as you have enough leads being generated at the top of funnel. Do not hire more AEs unless you can “keep them fed.” In my experience, AEs are rarely self-feeding and need marketing support to generate inbound leads. A great AE will generate at most 50% of their leads through their own outbound effort.
Outbound motions are much harder than inbound so don’t assume production from any outbound channel until it is proven. Bottom-up SaaS products are a special case where all the leads are generated by the product, making growth much more predictable and efficient. In general, bottom-up SaaS vendors shouldn’t waste their time on outbound; they should focus on creating greater awareness.
The last part of an AE’s sales plan is their territory. A territory describes the boundaries within which the AE can sell. To avoid channel conflict and ensure adequate coverage, the world should be divided into territories that are “M.E.C.E.” (mutually exclusive and collectively exhaustive). There may be some parts of the world that you’re not selling into yet. That’s fine – inbound leads can go into an inbox until those territories are ready to be assigned.
There are a few different ways to divide up the world:
- Geos. Most commonly, leads are assigned to geographic territories based on their location (typically company headquarters). APIs connected to Salesforce (such as Clearbit or Zoom Info) can do this assignment automatically. Territories should be roughly the same size, not in geographic area, but in terms of the number of leads they generate. If the world is divided up fairly, AEs should be largely indifferent to the territory they get. As more AEs get hired, existing territories need to be broken up to create new patches for the new hires to work. As a SaaS vendor gets bigger and bigger, the territories get smaller and smaller. Offsetting this challenge for the AE is the fact that sales get easier as the vendor becomes more established and successful. Continued growth means that the vendor is able to extract more from less.
- Verticals. Instead of using geos, some SaaS vendors will create territories based on industry verticals. This makes sense when the product is highly specific to a particular type of customer. Specializing by vertical allows the AE to master those use cases.
- Round-Robin. Finally, early-stage startups will often divvy up the leads round-robin. This makes sense for small teams that don’t want the overhead of maintaining geos or verticals. This is a good place to start.
New territories, quotas, and plans should be rolled out quarterly at Sales Kickoff. This is also a time to retrain the sales team on product changes and best practices. You should figure out what your top AEs are doing right and seek to replicate those behaviors across the team.
Expansion and Renewals
A perennial question is who should get credit for expansion and renewals.
I like to let an AE keep the account for 12 months from the initial close to incentivize “land and expand” deals. Any expansion in the account during that time is considered New ARR for which the AE receives full quota credit.
After 12 months, the account becomes a renewal, which is subject to a separate quota and commission rate and may be worked by a different rep. Commission rates on Existing ARR should be much lower than for New ARR.
There are several different options for assigning renewals, and each has its advantages and disadvantages:
- Original owner. Renewals can stay with their original owner – the sales rep who is most familiar with the account. The advantage is obvious, but the problem is that tenured reps will build a “book of business” and spend less and less time closing new business. This turns the best “hunters” into “farmers.” Eventually there will be a need for some kind of reassignment.
- Territories. Renewals can be assigned based on geographic territories just like new business. If an AE expands the deal, the expansion is considered New ARR and applies to their new business quota. This approach is the most democratic, because it assigns juicy opportunities for expansion to the entire team, but it can also result in important renewals being assigned to newer and less experienced reps who could mishandle them.
- Specialists. Renewals can be handled by specialists, typically elite sellers selected for the significant potential of these opportunities to impact ARR. This is what we did at my company Yammer, and it proved effective at maximizing these opportunities.
- CSMs. Finally, in some companies, CSMs handle the renewals. I am not a fan of this approach. While it can be fine for mature vendors, in the early years of a startup, AEs are much more likely to maximize the value of the renewal or to save a troubled deal. Thus, I prefer to see CSMs partnered with AEs and bonused based on customer retention, rather than owning the renewal themselves.
Finally, the Rule of 10 yields some insights about sales productivity.
If an AE is unable to generate at least $400k/year in New ARR (implying $80k-100k OTEs), a sales-driven distribution strategy may not pencil. Moreover, if your product requires very high-paid, experienced sellers, then it also needs to generate the contract sizes that justify their quotas. If your product generates only small contract values, that’s fine as long as sales velocity is high and junior reps can be hired to sell it.
Since OTE is 20% of sales, the fully-loaded cost of an AE will represent about a 25% cost of sales. Sales overhead (management, operations, sales development) will typically cost another 15-25% of sales. That means you can spend about 50% of New ARR on Marketing CAC (lead gen) and still keep your payback under 12 months. Of course, these are just rules of thumb – be sure to check the actual numbers.
I see a lot of companies implementing sales ad hoc, and they usually come around to some version of these principles, after experiencing some confusion and pain. If you stick to these simple math-based rules, it will be much easier to build out your sales function.
- Accelerator – the increase in Commission Rate that an AE receives once they’ve hit quota in a given period.
- AE (Account Executive) – a sales rep.
- Base Salary – the AE’s guaranteed compensation.
- Commission Rate – the percent of New ARR paid to the AE as an incentive, typically 10%.
- Geos – geographic territories, a process for assigning leads based on location.
- M.E.C.E. (“mutually exclusive and complete exhaustive”) – a principle for dividing up the entire world into non-competing territories.
- OTE (“on-target earnings”) – the sum of the AE’s Base Salary and Variable Pay.
- Quota – the New ARR that an AE is expected to close within a given period.
- Quota Attainment – the percent of Quota actually hit by an AE (as opposed to the amount specified in plan).
- Quota Capacity – the sum of the individual quotas on a team; the amount of new sales generated if everyone on the team hits quota.
- Ramp – the period where a new AE becomes productive. Ramp times vary based on your product and industry. Sales comp should factor in a ramp schedule so new reps have time to hit full productivity without their OTE being penalized.
- Round Robin – lead assignment process where all sales reps are assigned leads in a rotational order.
- Rule of 10 – Typical AE quota should equal 10x base salary. Most other compensation math hinges on this rule.
- Territory – the boundaries describing where an AE can sell.
- Variable Pay – the incentive compensation that the AE receives for hitting quota (i.e. Quota times Commission Rate).