Clawback, also known as commission recoupment, is a non-mandatory clause in the sales commission agreement, in other words, the contract governing the variable remuneration of sales reps.
In this article, we'll take a look at the advantages and disadvantages of this practice, both for the company and for the sales reps!
Next, we'll look at the different calculation methods available, illustrating them with a concrete example. Finally, Qobra's experts will give you their clawback tips and best practices.
1. What is clawback?
Clawback is a clause authorizing the company to recover all or part of a commission from an employee, with or without interest, and under certain conditions specified in the letter of objectives.
Once included in the letter of objectives, this clause is generally non-negotiable, although any amount recovered must be justified by the company.
In particular, clawback protects the employer from financial loss due to fraudulent, illegal or non-compliant actions on the part of the sales rep.
It is also used by some companies in the event of cancellation or termination of a contract within a specific period, which must be included in the commission recapture clause.
📌 The Hubspot example
HubSpot has introduced clawback for the first four months of new customer contracts. Specifically, if a customer cancels a contract less than four months after signing up, Hubspot automatically recovers the full commission from the sales rep who sold the contract.
For example, if the commission rate is 5% for each new contract, and a sales rep signs a contract worth €20,000 and the contract is cancelled 2 months after signing, Hubspot will recover the €1,000 commission previously paid to the sales rep.
2. The benefits of clawback
At first glance, the clawback system seems to be advantageous for the company, but much less so for the sales reps. So let's take a closer look at the positive consequences of clawback for both employer and employee.
Protect the company from potential financial loss
Generally speaking, employees receive variable commissions when they contribute to generating sales for their company. On this basis, they are paid a percentage of these sales.
Ultimately, if this revenue is not generated, the company will suffer a loss because it has had to pay a commission for a deal that was not completed. If this financial loss is caused by the sales rep for one of the reasons set out in his letter of objectives (fraud, short-term termination of the contract, etc.), the recovery clause enables the company to recover the commission paid.
The commission recovery clause guides companies towards sustainable growth, which benefits both the company and its employees.
Legal protection for the company
In the event of inappropriate behaviour on the part of an employee on a sale where they receive commission, clawback offers the company legal grounds to protect itself legally and claim reimbursement or even compensation with interest.
Generally speaking, commission recoupment is rarely used for this purpose. However, it does act as a deterrent to sales reps tempted to commit fraud.
Encouraging sales reps to build customer loyalty
Clawback encourages sales reps to focus on prospects who will bring sustainable growth to the company, and for whom the product and/or service really meets their needs.
Logically, to avoid potentially losing their commission, sales reps carefully qualify each of their prospects.
Improving the customer experience
By introducing clawback, the company is also encouraging sales reps to improve the customer experience. It encourages them to monitor their customers' onboarding and ensure that they are satisfied.
In other words, by including a commission recoupment clause, the company ensures that its sales reps assist their customers throughout their integration phase, and thus reap all the benefits of the product and/or service provided.
Pay commissions before receiving payment from customers
To motivate and reward sales reps, and even to avoid frustration, some companies pay commission when the contract is signed, before receiving full payment from the customer.
In this situation, clawback means that companies do not incur losses if the contract is cancelled or if they have not received payment in full.
Turning POCs into customer contracts
Nowadays, many companies sell POCs (Proof Of Concept), particularly to key accounts, to ensure that the product and/or service meets their expectations and needs.
By introducing a commission recovery clause on POCs, the company encourages its sales reps to finalise their sales in order to collect the full amount of the contracts.
3. The disadvantages of clawback
As we have just seen, the main purpose of clawback is to help the company achieve sustainable growth. However, commission clawback also has negative consequences.
Lack of visibility and transparency
The principle of clawback can have a considerable impact on the minds of sales reps. They can be stubborn about the consequences for their pay, forcing them to keep their own accounts to make sure they get paid the right amount at the right time. An action that distracts them from their core business.
What's more, depending on the company, the way clawback works can be more or less complex and opaque.
It is therefore essential for companies to provide total transparency on the principle of commission recoupment and its progress. Otherwise, companies run the risk of turnover.
Commission management platforms such as Qobra allow sales reps to track their commissions in real time, but also to get an in-depth, autonomous breakdown of their past and current commissions.
Depending on the company, there are two different methods for recovering all or part of a commission. The first is to recover it directly on a retroactive basis, while the second is to set up a negative quota for the next commission period.
Regardless of the method used, this has a considerable impact on the management of a company's accounts. This is all the more important for public companies, those listed on the stock exchange and those subject to ASC 606.
Legal and financial consequences
As stated above, it is essential to detail your clawback system and to follow it to the letter. No calculation or accounting errors are allowed.
And with good reason, the company is exposing itself to heavy legal proceedings and substantial compensation.
📖 For the record...
In 2017, Oracle employees took their employer to court over commission clawbacks. The company was sued for $150 million.
5. 3 clawback methods
To help you understand the different clawback methods, we're going to illustrate them with a practical example!
By way of example, here is the structure of the commission plan for company "X":
- Indicator: Annual Recurring Revenue (ARR)
- Period 1 quota (example: 1st quarter): €100,000
- Period 2 quota (example: 2nd quarter): €200,000
- Commission rate up to quota: 10%
- Commission over and above the quota: 15%
- Commission recovery clause for all contracts cancelled or terminated within 6 months of being taken out
And here are the sales reps for company "X" for periods 1 and 2:
Retroactive clawback consists of recovering the commission directly from the sales rep when justified by an event specified in the clause (cancellation or termination of the contract, fraudulent or illegal action, etc.).
In January, a sales rep from company "X" signs a new contract worth €50,000. As defined in his objective letter, he is to receive 10% of the total value of the contract, i.e. €5,000 in this example.
However, the commission recovery clause states that if a contract is terminated less than 6 months after it was signed, the company will recover the full commission. In June, the customer terminated the contract. The company is therefore able to recover the €5,000 previously paid to the sales rep.
It is important to note that this method of commission clawback is particularly suitable for companies that pay commission per transaction or where the seller has not exceeded his quota. In other words, as soon as a company uses commission tiers or commission accelerators and these are reached, the principle of retroactive clawback becomes more complex.
To take the example of company "X" again, a sales rep signs a contract "A" for €50,000 in January, but the contract is terminated in June. The structure of the commission plan indicates that the sales rep earns 10% commission up to €100,000, and 15% for additional contracts signed during the period.
Now let's assume that the sales rep signed an additional "B" contract in February for €75,000. The sales rep would then receive 10% of €50,000 (i.e. €5,000) and 15% of €25,000 (i.e. €3,750), since he or she has exceeded the initial quota and therefore benefits from the second tier.
However, with the clawback system, the sales rep's quota falls back to €75,000 for period 1 and is therefore no longer €125,000 since contract "A" has been terminated. At the end of the day, the sales rep must therefore return his 10% commission on the €50,000 of contract "A" (i.e. €5,000), and his commission on contract "B" is recalculated at 10% (i.e. €7,500), so he also owes the difference between his initial commission on contract "B" and his final commission (i.e. €1,250).
In practical terms, by deducting the clawback from period 1 to period 2, the commission that the employee will receive for period 2 is no longer €27,500 but €21,250.
This second method involves recording the cancelled or terminated sales contract as a new sales contract but with a negative amount, and applying it to the period in which the cancellation or termination was confirmed.
In practical terms, commission statements are clearer for sales reps, as they no longer have to check for themselves that the amounts recovered from commissions correspond to the initial amounts. This is displayed as a contract with a negative amount and an associated negative commission.
This method is also simpler to manage for the employee(s) in charge of calculating and managing commissions: no need to check that the cancellation date is the right one, simply add a new line with a negative sale. What's more, this method treats a clawback as a sale and therefore uses the same rules as the commission structure.
Let's take the example of the sales rep for company "X". In June, contract "A" signed in January is cancelled. The company will record this cancellation as a negative transaction of €50,000 (i.e. commission of €5,000), with an effective date in June. In practical terms, to reach the quota for period 2 and earn a commission rate of 10%, the sales rep must record €250,000 in new contracts over period 2, rather than €200,000.
Using the example above, the sales rep for company "X" signed contract "C" in April for €100,000 and contract "D" in May for €150,000. In practical terms, his commission for contract "C" is 10% of €100,000 (i.e. €10,000), and for contract "D", 10% of €100,000 (i.e. €10,000) and 15% of €50,000 (i.e. €7,500). However, the cancellation of contract "A" in the amount of €50,000 is booked in June and is therefore subject to a commission rate of 15% (i.e. €7,500).
As shown in the example above, this clawback method protects companies more against exceeding their quotas, to the detriment of sales reps. As proof, in the example used, there is a difference of €1,250 between method 1 and method 2.
This is a source of demotivation for sales reps, as they may feel that clawback is an obstacle to exceeding quotas. Ultimately, this can encourage them to use what is known as the "fridge effect", i.e. to delay or block a sales contract until the next period in order to exceed the quota, and thus earn higher commissions.
Clawback: combination of the two methods
This third method consists of retroactively recovering a commission by recalculating the quota for period 1 without impacting period 2.
In practical terms, this can prevent the company from exceeding its quota for period 1, while not demotivating sales reps to avoid exceeding their quota for period 2.
To take the example of company "X" again, the sales rep signed a €50,000 contract in January with a commission rate of 10% (i.e. €5,000). However, the contract was cancelled by the buyer in June, less than 6 months after it was signed. In accordance with the commission recovery clause, the employer will therefore recover the entire commission.
To calculate the exact amount of the clawback, the company will look back at the sales reps made in period 1. The cancelled contract will simply be a new line added just below the initial sale, with the same amount but in negative.
By carrying out this operation, the sales rep's commission for period 1 changes because he does not reach the second commission rate of 15%. In the end, instead of earning €13,750, he will earn €7,500, i.e. a difference of €6,250, which will be deducted from commission payments for period 2. The commission for period 2 is therefore €21,250 instead of €27,500.
Although this third method combines the advantages of retroactive and non-retroactive clawback, it is fairly complex to implement, particularly for companies subject to ASC 606.
6. Clawback: 7 tips and best practice
Clawback can be a complex process at first sight, both for the company and the sales reps. However, there is a list of best practices to simplify the system and make it easier to manage.
Establish simple and few clawbacks
Given the complexity that clawback can reflect, it is essential to limit the number of possible cases and to simplify them as much as possible.
In practical terms, this involves defining 3 cases of clawback: fraudulent action by the sales rep, illegal action by the sales rep and cancellation of the sales contract by the buyer.
Then, for each of the cases listed above, the actions that may trigger them must be precisely defined. For example, entering the wrong amount on a sales contract is a fraudulent action by a sales rep.
Define trigger thresholds and reasonable amounts
For a clawback scheme to have the desired impact for both the company and the sales reps, it is strongly recommended not to charge excessive amounts or impose long recovery periods.
This can only lead to demotivation, mistrust and frustration, and ultimately to high staff turnover and a drop in sales rep performance.
For example, commission recoupments must be made no later than 6 months after a sale, and in the worst-case scenario the amounts can reach the full commission.
Fairness between sales reps
Logically, it is essential that the clawback system applies to all sales reps and respects the same conditions for all.
Communication and transparency
Communication and transparency are clearly the two most important points!
Firstly, the clawback system must be explained orally and in writing to all sales reps on a regular basis, in a clear and detailed manner.
In practical terms, sales reps need to understand :
- The aim of clawback
- Use cases
- How it works
- The potential impact on their pay
- Legal conditions
They need to understand that commission recapture is designed to support sustainable growth for their business.
What's more, they need to have simple, transparent access at all times to a range of resources (FAQ, Notion, Google Drive, Welcome Booklet, Sales playbook, etc.).
Regularly review the clawback clause
Like a variable remuneration plan, a commission recoupment clause should be reviewed in the light of the company's stage of maturity and the market.
An in-depth analysis must therefore be carried out on a regular basis to observe its impact, so that it can be modified to have the desired effect.
Drafting the clawback clause with a lawyer
To ensure that the clawback clause complies with current regulations, it is strongly recommended that the clause is drafted or proofread by an expert (lawyer, legal expert, etc.).
It is vital to ensure that the clause complies with all the rules permitted in the state or country in which it comes into force.
As we have seen throughout this article, setting up such a system is a long, tedious and time-consuming process for the teams responsible for managing commissions. What's more, it can create a lot of tension with sales reps.
Fortunately, there are now solutions like Qobra that can automate clawback. All companies have to do is define the operating rules and implement them in just a few clicks in the commission management platform.
By automating the process, as well as saving precious time, no manual errors can occur, which considerably reduces the risk of friction and frustration.
What's more, a platform such as Qobra provides sales reps with complete transparency over each commission earned, both in terms of its origin and the details of the amount recovered.
The last word...
The clawback system has a number of advantages. Firstly, it enables the company to protect itself financially and legally. Secondly, from a sales rep point of view, it encourages sales reps to build customer loyalty and improve the customer experience.
The wide range of clawback methods (retroactive, non-retroactive or a combination of the two) means that companies can choose the one that suits them best.
However, whatever method you choose, you should not overlook the disadvantages of such a system. For one thing, it is undeniably complex, time-consuming and stressful. What's more, the lack of visibility and transparency among sales reps can have a considerable impact on the company: mistrust, frustration, dissatisfaction, turnover, lower sales performance, etc.
Fortunately, these disastrous consequences can be easily avoided thanks to commission management platforms such as Qobra.
Qobra automates the calculation and management of commission clawbacks, enabling the teams responsible for managing them to save a considerable amount of time and avoid any potential errors. Qobra also provides sales reps with total transparency on the origin, operation and details of clawback amounts.