The basics of sales commission agreements

Do you pay your sales representatives through commissions? Read more to learn about the basics of drafting a sales commission agreement.

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by Belle Wong, J.D.

Belle Wong, is a freelance writer specializing in small business, personal finance, banking, and tech/SAAS. She .

Contents

Updated on: December 14, 2023 · 3 min read

• Employes vs. independent conntractors
• The sales commission plan
• Termination of a sales representative

A sales agent commission agreement sets out the details of the commission to be paid by your small business to your sales representative. Having such a document in place may help protect your business from liability.

Employes vs. independent conntractors

The type of sales commission agreement you use depends on the legal relationship between the business and your sales representative. If your sales rep is your employee, you must use an employer-employee sales commission agreement, while an independent contractor sales commission agreement should be used if your sales rep is an independent contractor .

Using the correct agreement is important from an income tax perspective. For example, employers are responsible for withholding income tax from amounts paid to employees but not for amounts paid to an independent contractor.

If you are giving the sales representative the exclusive right to sell your product, you should use an exclusive sales agreement. Otherwise, a nonexclusive sales representative agreement should suit your purposes.

The sales commission plan

Your business's commission plan forms the foundation of the sales commission agreement. You want the final contract to be comprehensive enough to cover a number of potential scenarios that could arise during the course of the relationship between you and your sales representative.

To this end, a properly drafted agreement should provide detail about all the features of your sales commission plan, including:

• When commission is earned. It's important that the agreement clearly spells out exactly when the sales representative earns their commission. For example, depending on the circumstances of the sale, there can be a big difference between crediting a sales agent with commissions when an order is booked versus when the order is actually paid for.
• When commissions are to be paid. The agreement should also state when commissions are to be paid and the date up to when the amount of each payment is calculated. For example, the agreement might state that commissions are to be paid on the 15th of every month and that each commission payment includes all commissions earned as of the seventh of each month.
• The consequences of refunds, cancellations, or default of payment. In an ideal world, every sale a business makes is a final one. But as all small business owners know, a number of events can happen to turn a sale into a nonsale. Whether it's the return of a product for a refund, the cancellation of an order, or a customer who defaults on payment, your agreement needs to account for any of these situations and the impact they may have on commissions.
• Your commission formula. Your agreement should fully detail all aspects of your commission structure, regardless of whether your sales representative is being paid a salary plus commissions or is under a commission-only compensation plan. The details should include not only the amount your representative is to be paid for each sale they make but also the equation used to determine the sales amount on which that commission is calculated. For example, if commission is to be paid on sales net of taxes or shipping costs, this should be stated clearly in your agreement.
• Performance incentives. Many businesses offer their sales reps incentives as motivation to achieve more sales, such as bonuses on reaching a specific number of sales or a commission structure where the percentages paid out are tiered.

Termination of a sales representative

Your agreement also needs to account for if the sales rep's employment with you ends, particularly if any of your sales are generated by ongoing or continuous commissions. In such cases, your agreement needs to address who receives continuing commissions from an original sale.

For example, a business selling a machine that needs regular maintenance offers commission for these maintenance services to the representative who made the original sale. If that sales rep leaves their employment with the company, the agreement needs to set out what happens to any future commission that is earned as a result of the initial sale.

If you employ a sales agent or are using an independent sales representative to help market your goods or services, it's prudent to use a properly drafted sales commission agreement. Such an agreement goes a long way to protecting both you and your representative in the event of any misunderstandings about how commissions are to be paid.

This article is for informational purposes. This content is not legal advice, it is the expression of the author and has not been evaluated by LegalZoom for accuracy or changes in the law.

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