Incentive or Commission clawbacks can be favorable or detrimental to a business, depending on how it is enforced. Read all that there is about commission clawbacks, starting with the definition, an example, advantages, disadvantages, and best practices. By the end of it, you will know how to formulate a commission clawback policy that is fair for all.
While customer churn and contract cancellation are inevitable, the degree to which it occurs varies across industries.
For instance, for SaaS companies, it hovers at around an average of 13.2% with ideal values near 7%, whereas residential real estate contracts saw a cancellation rate of 14.9% in June 2022 alone!
One can philosophize that the customer wasn't a "good fit" and move on.
But what about the sales commission that your business may have doled out to the rep that closed this deal? Does it mean that you have to count it as your loss?
Well, here's where clawbacks enter the scene.
Below, I’ll walk you through everything you should know about commission clawback, from its very definition to some best practices.
What is an Incentive or Commission Clawback?
A commission clawback is a contractual provision, typically non-negotiable, wherein any money already paid to an employee can be recovered – sometimes with penal interest.
Such a provision is generally incorporated in employment contracts surrounding incentive-based pay like commissions and bonuses. The clause is triggered under specific conditions, such as when a customer cancels the contract abruptly.
Why Do Businesses Use Clawbacks?
Even though clawbacks sound like a punishment doled out to salespersons, they’re not necessarily so. Commission clawbacks can prove to be useful under the following conditions:
1. To protect the interests of the company
Ideally, sales reps earn a commission on the revenue that they’ve helped generate. However, failure to do so would result in the company bearing a loss.
Commission clawbacks ensure that businesses don’t overpay the sales teams in case of unprecedented revenue changes or contract termination.
At the same time, they discourage any sales malpractices or accounting fraud. Accordingly, salespersons will only pursue relevant businesses and claim proportional sales commissions.
2. To ensure customer retention
Customer churn is a serious issue afflicting businesses of all shapes and sizes. It’s even more prevalent in business models that follow a subscription-based payment model.
With incentive or commission clawbacks in the picture, sales reps can focus their energies on winning over customers that offer high lifetime value (LTV).
They can also actively participate in customer onboarding to ensure that the customers stick around – attracting the projected revenue.
3. Commission payouts precede customer payments
Businesses may settle sales commissions even before they receive customer payments. Such payouts make sense as they can motivate salespersons to bring their A-game consistently to hit their quota and even go beyond.
Here the commission clawbacks act as a guarantee that ensures companies don’t lose revenue in case the deals fall through or they fail to receive the payment in full.
4. They maintain critical cash flow
If your business is just starting out, you might still be running the trial-and-error method of discovering your target customer base.
In such settings, commission clawbacks can come in handy to maintain a certain degree of liquidity during the “error” phase of such an experiment. It also ensures that your sales team focuses on selling to the right customers with the right strategies.
5. Commissions linked with proof of concepts
Organizations that sell Proof of Concept (POC) may award commissions for landing the POC.
However, they also use commission clawbacks as a protective measure to ensure a successful rollout followed by full account settlement. This means that the salesperson will also proactively work toward ensuring customer satisfaction.
Disadvantages of Using Clawbacks
While commission clawbacks make sense, they also present the following obstacles:
1. They can be demotivating
Let’s face it; nobody likes repaying their employers, least of all the sales team that often works hard to clinch every deal. The problem gets worse if the reps fail to understand why clawbacks are put in place.
As such, commission clawbacks may feel like a harsh punishment that undermines their effort.
Additionally, it can give rise to concerning malpractices like shadow accounting (the practice of maintaining an account of transactions independent of the primary bookkeeping process).
2. They can be tough to implement
Even the most carefully crafted and justifiable commission clawback policies contain some amount of complexity and ambiguity.
Moreover, different clawback clauses may correspond to different scenarios, which can add to the confusion. The lack of visibility and comprehension can breed resentment or attract pushback from sales teams during implementation.
3. They are difficult to calculate
Commission clawbacks are an accounting nightmare.
For starters, there are several ways to enforce commission clawbacks, either through exact payout amount or negative quota credit.
Managing the books also becomes difficult for organizations that have to publicly declare their earnings as they have to adhere to stricter account management regulations.
Additionally, large clawbacks can skew the numbers and lead to mistrust.
Clawbacks Best Practices
Clearly, commission clawback is an act of fine balance. Here are a few tips that can help you hit the sweet spot as you walk the line:
1. Set clear triggers for clawbacks
Care and clarity are the foundational elements of a fair clawback policy.
Take HubSpot, for example, the company states that the clawback will be in effect for the first four months since the customer signs up. This timeline clarity leaves no ambiguity about the clawback trigger.
Similarly, you can incorporate clear triggers for clawback within the policy and employee contracts.
2. Educate, inform, and communicate
Clawbacks are going to sound unfair and demotivating if you fail to put in the effort to communicate why they are set in place. It’s your responsibility to make the sales reps understand that clawbacks support sales success and contribute to organizational growth.
So, educate, inform, and communicate such sensitive policies with the employee in mind.
3. Ensure clawback transparency
Anger is a natural knee-jerk response to clawbacks. However, you can diffuse some of the tension by maintaining transparency in clawback processing.
Here’s what you can do:
- Make clear why the clawback has come into effect.
- Pinpoint the deal under fire.
- Explain the impact of the clawback on the payout.
Such transparency will inculcate feelings of mutual trust and understanding.
4. Get all teams on the same page
Your sales team does not operate in isolation, especially when successive activities like customer onboarding and product rollout are involved. As such, additional teams are also stakeholders of success.
Attribute accountability throughout the salesforce and grant incentives so that everyone plays their part to perfection.
5. Use clawbacks sparingly
Needless to say, clawbacks must be used only when absolutely necessary.
You should think of this fallback mechanism only when everything fails.
After all, you do not want a disgruntled sales team in your hands with no explainable justification for docking their pay!
Read: Using clawbacks in staffing and recruiting industry
Key Takeaways
Commission clawbacks can help protect the interest of the company, maintain critical cash flow, and more.
However, it comes with its own set of drawbacks like implementation and calculation issues.
You can avoid this by using clawbacks the right way.
Use the best practices mentioned in this article to stay on top of your clawback and find the right balance!
Frequently asked questions regarding clawback
1. What is an example of a commission clawback?
If a recruiter places a candidate who leaves the company within three months, the employer may claw back some or all of the commission from the recruiter based on the initial agreement.
2. Can commissions be taken back?
Yes, commissions can be taken back if a clawback clause is part of the compensation agreement. This clause specifies conditions under which the employer can reclaim previously paid commissions. Common reasons include customer refunds, contract cancellations, early employee departures, or unmet performance milestones.
3. What is compensated clawback?
Compensated clawback refers to a structured approach where the employer deducts only a portion of the commission rather than the full amount. For instance, if a customer cancels a contract, instead of reclaiming the entire commission, the employer may take back an amount on a pro-rata basis.
4. What are the clawback rules?
Clawback rules vary by company but typically include the following key points:
- Clawback period: Specifies the time frame during which a clawback can occur (e.g., 3 to 6 months).
- Eligible scenarios: Defines the situations triggering a clawback.
- Clawback amount: Details the percentage or fixed amount
- Payment method: Outlines how the clawed-back amount will be deducted (e.g., from future commissions or as a payroll adjustment)
