What is an Independent Sales Rep Agreement?
Independent sales representative agreements are contracts that appoint independent agents to sell products or services in a particular territory. The agent acts on behalf of the principal (the business entity), typically on a commission basis. The agreement is drawn up between the company or entity and the independent agent with a detailed description of the relationship. The agreement will typically specify the rights of the agent and the company in regards to pricing, territory, non-solicitation of third parties, confidentiality, non-competition and any other issues particular to that relationship . An independent sales representative agreement will be used by those companies, partnerships or individuals who wish to extend the reach of their business by securing the services of local agents that possess knowledge of the tribulations of selling in their local area. This may include knowledge of competition, access to information, and local contacts. It is also a good way of bringing needed expertise when the manufacturer or supplier cannot either afford to do the selling or train the local sales agent or such activity is not feasible for the supplier or manufacturer. In such cases, the local sales agent will be responsible for educating the local sales personnel, will make the local sales calls, and will be responsible for the follow-up of the actual sales.
The Basic Terms of a Sales Rep Agreement
The essential components of an independent sales representative agreement are not much different than the components of any contract. These elements include the parties’ names, their roles, the consideration (i.e., how the rep gets paid) and the terms (i.e., length). Of course, each of these components has their own nuances in the context of what is being sold and who is selling it.
An independent sales representative is a non-employee sales rep that works in a particular territory for one or more manufacturers. The territory can be a matter of geography, like one or more states and/or a specific customer list (sometimes called "house accounts").
A rep agreement should explain the rep’s role, which is to make best efforts to sell, promote, etc. It should make clear that the sales rep is not an employee of the manufacturer, but instead is an independent contractor. A description of the rep’s efforts and obligations can be included, such as to attend tradeshows, distribute samples and literature, perform marketing efforts, meet sales quotas, etc. A clause that says that this description of efforts is for guidance only and is not legally binding is recommended. It would help if the manufacturer provided vendor training and attended some sales presentations with the rep to provide added direction.
The compensation section needs to address when commissions are payable after a sale to a customer. For example, if the rep sells $100,000 of product A that month, 50% is paid out in commission the following month and 50% is paid out the month after that. The calculation should be made clear since it can vary greatly from company to company. If the rep visit a customer once and sells product A and later sells product B without visiting the customer at all, how much does the rep get? Is it pro-rated, so that if the commission for A is 15% a year is split 2/3 and the commission for B is 10% a year, the rep would get the monthly commission for these two products as follows:
A: $100,000 x 15% /12 x 1/3
B: $10,000 x 10% /12 x 1/3
A + B = $5,000 + $277 = $5,277, divided by
$100,277 = 5.26%, the rep’s commission for April.
It is important to spell out exactly what counts toward sales—including reorders—and how commissions are calculated. Also, whether the commission will be paid out if the customer goes out of business, refuses to pay, or if a competitor gives the account a credit, or if the manufacturer is responsible for a bad batch. The manufacturer may want to consider tying the payout to when the customer pays the manufacturer which will incentivize the rep to make sure the customer pays. A contingent upon payment clause should reference back to the definition of commission due.
The exclusivity clause (sometimes called "shop rights" or "first refusal," etc.) should specify whether the manufacturer is allowing the rep sole rights or whether the manufacturer is free to appoint other reps and/or sell the same product in the same territory. The rep will certainly want exclusivity in their territory. The manufacturer should try to keep the right to sell the same product to the same customer as the rep do and to compete with the rep in the rep’s territory in certain circumstances. Consider using language that allows the manufacturer to sell through a former employee of the manufacturer to avoid interfering with sales to a particular customer that has already bought the product from the manufacturer. Allowing the manufacturer to sell directly, either in general or at least in certain situations, will also maintain some leverage for the manufacturer with respect to the reps.
Reasons to Engage an Independent Sales Rep
There are several reasons for utilizing an independent sales representative. Depending on the industry, one of the primary reasons for utilizing an independent sales representative is to expand into new geographic areas without the cost of hiring and maintaining an in-house employee. Hu in his book, The Art of War,Systems, Inc. At the very least, an independent sales representative can provide a beachhead for potential geographic expansion, at a comparatively low-cost.
Another reason for utilizing independent sales representatives is cost flexibility. Ninety-six percent of independent sales representatives are paid only on commission. Hu, The Art of War, Inc. p. 47. The remaining four percent are typically paid a base salary plus a commission or commission-only. The use of commission-only (or base salary plus commission) independent sales representative allows companies to spread out their selling expenses over a greater volume of sales, which can improve cash flow and reduce selling expenses as a percentage of total sales. Id.
A third reason for utilizing independent sales representatives is sales flexibility. Unlike regular employees, if a manufacturer or wholesaler wants to drop a sales representative, it can do so immediately, without the time and expense of termination and turnover costs associated with regular employees. Id. at 58. This flexibility allows a manufacturer or wholesaler to expand or reduce sales coverage without the sales staff turnover that would be necessary if their internal sales force were reduced as a result of low sales. Id. This sales flexibility is especially important for expanding from one geographic area into another geographic area.
Another issue for manufacturers and wholesalers to consider when deciding whether to utilize independent sales representatives is their willingness to terminate those representative when the relationship is no longer beneficial to the wholesaler or manufacturer. Hu, The Art of War, Inc., p. 58. It is important for manufacturers and wholesalers to determine whether independent sales representatives have a history of successfully terminating relationships with companies that no longer serve them.
Legal Issues and Compliance
Contracting with independent sales representatives comes with an array of legal considerations that do not apply to employee salespeople, and newer companies who are unfamiliar with hiring and working with ISRs on a contractual basis need to be certain they stay in the lines of the law. In the simplest of terms, an ISR is self-employed, and as such is required to pay his or her own taxes, carry their own health care, and be on call to other buyers. ISRs are not covered under workers compensation insurance, and when ISRs do enter into a relationship with a company as a representative of that company’s products, most are responsible for having their own liability protection. Of course, these factors vary from state to state, but they broadly apply when engaged in ISR contracts. The important thing to note here is that these protections are not only in place to protect the ISR themselves — they are also present to protect the company doing the hiring. Companies specializing in working with ISR contracts should be aware of the most common pitfalls when creating an arrangement of this nature.
First off, the IRS guidelines for classifying ISRs go like this: "If an individual is an agent or commission salesperson and is regularly engaged by you for substantial continuance of time, you may treat all amounts received by the individual for sales made by them as received by an employee…. However, if the individual sells your goods or services however and receives amounts from you for performing such services, you must treat the payments as compensation for services for which tax withholding must be made."
These are the two basic types of sales contracts in this area: (1) Commission Agent: A commission agent (or commission-only salesperson) is a representative who sells products or services on behalf of a third-party. The third-party will pay the commission agent for their work; the money comes directly from the company, NOT from the third-party client. The commission agent is paid on average a minimum of 15% (yes, even for difficult to sell items). This type of ISR does not benefit from health insurance or any additional company incentives.
(2) Reseller Agent: A reseller agent retains a business relationship with a third-party, reselling to their own client base while acting as a representative of the company (the company in effect outsources the representative’s listening in with their own client list). Reseller agents invoice the end client directly for their work, and are paid a commission by the company for their services. Reseller agents typically work on a larger, geographic scale than commission agents. Reseller agents are not paid based on commission, but instead receive a base fee for every completed sale. Reseller agents DO receive perks like health insurance and additional commissions/bonuses.
One of the biggest problems revolving around ISRs is the potential for misclassification. If a company misclassifies an employee as an ISR, they could be looking at major fines from the IRS. In the United States, the IRS makes no allowance for one specific type of ISR contract over another. While there may be some allowances from the state in which the ISR resides (or in which the company resides), the majority of federal guidelines are the same. Federal guidelines state that a "worker is an employee under the common-law rules if you have the right to control how they are paid, whether they work on a full-time basis, whether they are assigned exclusively to you, and whether they perform services that can be performed elsewhere."
The bottom line: The person is an employee if they are under the direct control of the employer (i.e., the person is told what to do and how to do it), and is not an employee if they are not under the direct control of the employer. ISRs should not be offered benefits like health insurance or other perks unless they are actual employees of the company. Best of all to avoid IRS fines, the work agreement between ISR and company should be in writing, outlining all sales-related expectations and compensation structure in addition to outlining the responsibilities of the company as a whole.
Sales Rep Agreement Best Practices
With any independent contractor agreement, you want to make sure that it is drafted in a way which gives you the protections you need. Here are some important best practices for doing that in an independent sales representative agreement.
Limits on Terms
If you have an independent sales rep that is performing well, you will want them to continue working for you for as long as possible. However, offering them an open-ended contract is not in your interests. Therefore, you should always limit the terms of the agreement. The Typical sales representative agreement in this context is two years. Without limits on the agreement terms, the independent sales representative would have the right to receive commissions indefinitely. You will be in a position of perpetual liability for potentially years’ worth of commissions unless you include a way to limit the term of the agreement.
Clarity on Territory
You want to include clarity on where the independent sales rep will be operating in order to avoid any dispute later. Be very specific about territories and any changes to those territories in the future. There is always the possibility that conflicts and shortfalls in sales may occur . In either case, the team could attack both reps. You want to clarify all territories when drafting a clear sales representative agreement. This includes: The territories are crucial to defining who gets the commission from a sale. It also helps prevent friction between the two reps.
Only Pay Commissions on Fulfilling Contracts
You want to avoid overpaying on commissions. You want to limit your obligation to pay it out until the contract has been fulfilled. Most companies will base sales commissions on revenue. However, the payment should go to the rep that is responsible for fulfilling the contract. Even if they are not part of any installation or execution of terms, the rep should only get paid for fulfilled contracts. You could be on the hook for paying a rep that does not actually complete a sale.
Annual Forecasts
With a salesperson agreement, having annual forecasts is a best practice. This works well in case there is some ambiguity that the annual forecasts could be used to resolve. Yearly sales forecasts allow the rep and the company to review the status of those forecast so that you can agree on whether they have been met.
Sales Rep Agreement Dispute Resolution
Like any other type of legal contract, independent sales rep agreements often involve an array of disputes. Depending upon the nature of the dispute, there has to be a resolution one way or another. So how do companies and their sales representatives deal with these issues? The most obvious answer is to try and resolve the conflict through amicable negotiations, which can be a combination of what is outlined within the agreement and what is best for business. This dialogue is sometimes skipped when it is determined that only outside help such as a mediator or arbitrator can be brought in to facilitate the settlement of the disputes. Many agreements (as reviewed in the earlier part of this article) have policies in them concerning what parties need to do before resorting to litigation, which is often a last solution of sorts. In many cases, the outcome will either hinge on paperwork that determines compensation and other types of payments, or even whether or not there are outstanding debts owed to either party. In the case of a representative’s failure to provide certain types of performance, such as an agreed-upon number of sales, documentation will be critical for either party. The rep must keep clear and organized reports of performance and last commissions paid time periods to ensure that the compensation is accurate, while the company’s lack of documentation could be considered a breach on their end. If an outside entity is necessary, the types of arbitration are typically outlined in the agreement, with the usual difference between mediation and arbitration being that the former generally involves one person to help interpret the agreement as it relates to performance and the latter actually has binding powers to discuss compensation issues. Once mediation takes place, more often than not a settlement is reached that can help resolve the conflicts, but in some cases the parties are left with no choice but to pursue a legal course.
Negotiating a Sales Rep Agreement
The process of negotiating an independent sales agent agreement generally starts with a couple of phone calls or lunch meetings so that the parties can get to know each other a little and start the process of getting comfortable with the idea of working together. As with most commercial agreements, an effective negotiation process will result in a representative agreement that both parties feel is fair and reasonable under the circumstances. To reach this point typically requires a number of brief discussions and/or revisions to the sales representative agreement.
My suggestions during such a process are as follows:
- Whenever possible, the ability to collaborate and work together in a team-oriented fashion should be built into the process being used to negotiate the agreement. This sets the stage for the positive relationship that needs to exist for the sales agent and the principal to make the arrangement work.
- In determining what issues you need to have included in the agreement and what language you feel is necessary in order to meet your needs, it is important to do your due diligence to ensure that you understand the marketplace in which you will be selling your products. This could be in part dependent on the agency’s experience in the industry for which they are going to be selling.
- During this process, treat as very significant the time that you spend discussing those issues that seem most important. In most cases, the issues that seem to be the biggest points of contention at the outset of negotiations are not nearly as important in the long run as other issues that do not appear to be crucial. Conversely , some of the issues that seem to be most important to the negotiating parties may be the easiest to resolve. Either way, try to keep your eye on the ball. Understand what is most important to you and set your priorities accordingly.
- Sometimes the best approach to determining whether an issue you believe is crucial really is, or if it could change to something that will be more acceptable to you, is to allow some time to pass in between meetings. This time allows the parties to think through some of the issues that were discussed, along with the different potential outcomes, without having to prove their willingness to do whatever is necessary to resolve such issues.
- Don’t be afraid to approach an issue from a completely different perspective than the one being presented. Sometimes the most effective approach in getting what you want or getting past an impasse is to take a different perspective.
- Ask questions, listen to the responses, and don’t be judgmental. Try not to assume any responses to the questions you ask because you may be surprised.
- When you believe you have reached a conceptual agreement, summarize your recollection of the conceptual agreement with the other party to determine if you have both captured the same concepts.
"A good friend of mine says, ‘If the people we deal with have a sense that we are authentic and honorable, they usually act in a way that is authentic and honorable. If they don’t trust us, we will never get what we want.’"