On-Target Earnings: A Small Business Guide to OTE Compensation

When you're hiring for sales roles, candidates often ask about on-target earnings (OTE) before anything else. They want to know their expected earnings when they achieve 100% of their performance goals. Growing businesses competing for talent need to carefully plan their OTE structure. Too low, and you'll lose candidates to competitors. Too high with unrealistic quotas, and new hires might leave after becoming disillusioned. Let's break down what you need to know about on-target earnings, including common OTE splits and pitfalls to avoid.

What is OTE?

On-target earnings (OTE) is the projected annual income for quota-carrying roles when employees achieve their targets. It combines a guaranteed base salary with potential commissions or bonuses. You can think of it as the expected total compensation package. It's not a guarantee, but a realistic earnings benchmark based on performance. The formula is straightforward:

Base Salary + Target Variable Compensation = On-Target Earnings (OTE)

Example: If you offer a sales representative a base salary of $60,000 plus $40,000 in potential commissions for hitting quota, their on-target earnings equal $100,000.

Understanding on-target earnings helps you and your team set clear expectations. For you, it provides a framework for sales compensation and comparing roles across markets. For employees, it offers transparency about earning potential and the risk-reward balance of variable pay.

Common OTE Structures for Small Businesses

When developing your compensation strategy and finalizing compensation agreements, it's important to define the OTE split for quota-based roles. The split refers to the two parts of a salesperson's total potential compensation: a guaranteed base salary and variable performance-based pay. During salary negotiations and budget planning, you can refer to your OTE structure to explain the new hire's expected compensation. Here are some examples of common OTE splits:

The 50/50 Split

Many businesses start with an even split between base and variable pay. A $120,000 OTE role might offer a $60,000 base salary and a $60,000 target commission. This structure works well for experienced salespeople who are comfortable with income variability and businesses with predictable sales cycles.

Conservative Splits (60/40 or 70/30)

A conservative OTE split offers a higher base salary. This OTE structure reduces your employee's income volatility. It's more common for roles such as account management positions that require relationship building, industry roles with longer sales cycles, new market segments where quotas remain uncertain, and entry-level positions where reps need ramp time.

Variable-Heavy Structures

Some growing companies use 40/60 or even 30/70 splits. These OTE splits offer lower base salaries but higher earning potential. They often attract top performers. To be successful, these variable-heavy on-target earnings require careful quota setting and strong sales support systems.

Calculating On-Target Earnings: A Step-by-Step Example

Salary benchmarking is an essential step in establishing a fair and competitive pay structure for your business. Comparing similar jobs in companies of equal size to market data helps you paint a complete picture. Once you know the benchmarks, you can calculate the OTE for a new sales position. Here's an example:

1. Determine the Base Salary Research market rates for similar roles. For example, you may set a base salary of $75,000 for a mid-level account executive in your market.

2. Set Target Variable Compensation Decide the additional earnings at 100% quota achievement. Using a 50/50 split with the example above, the target variable compensation equals $75,000.

3. Calculate Total OTE $75,000 base + $75,000 variable = $150,000 on-target earnings (OTE)

4. Define the Quota and Commission Structure For example, if the annual quota equals $1.5 million in revenue, the rep earns 5% commission on closed deals. At 100% of the quota, they earn their full variable compensation.

Remember that actual earnings depend on performance. At 80% quota attainment, the rep would earn $75,000 base plus $60,000 in commissions (80% of the target variable), totaling $135,000.

Tax and Payroll Implications of OTE

Variable compensation creates additional payroll tasks. Commissions and bonuses require specific withholding treatment, as detailed in the IRS guidelines on supplemental wages. Small businesses need to:

• Withhold Appropriate Taxes: Commission payments are subject to federal income tax, Social Security, and Medicare withholding.

• Choose Withholding Methods: Use either the percentage method (22% federal withholding) or an aggregate method based on total compensation.

• Handle State Requirements: Each state has specific rules for commission taxation.

• Report Correctly: Include all variable compensation on W-2 forms.

Modern tools can help you simplify payroll and HR operations with user-friendly navigation and reliable support. They enable you to maintain compliance and manage your teams. For businesses using a Professional Employer Organization such as Justworks PEO, automated payroll processing handles these calculations, ensuring proper withholding and reporting across multiple states.

Common OTE Mistakes to Avoid

On-target earnings are not without potential pitfalls. Here are some examples:

Setting Unrealistic Quotas

Let historical data guide your quota setting. If only 30% of your sales team hits quota, your advertised OTE can mislead candidates and increase turnover. To avoid this, track attainment rates each quarter and adjust the targets to keep 60-70% of reps achieving quota.

Ignoring Ramp Periods

New hires need time to learn your products or services and build a pipeline. Support them with plans that gradually increase quotas over 3-6 months. Some companies guarantee 50-75% of OTE during ramp periods to support new sellers.

Creating Overly Complex Plans

When commission structures involve multiple products and varying rates, reps may struggle to understand their on-target earnings. Keep plans simple enough to explain in five minutes. Focus on 2-3 key metrics maximum.

Missing Clear Documentation

When you create an incentive compensation plan, you need to ensure that every OTE-based role has written documentation. It should cover the OTE split, quota definitions and measurement periods, commission calculation formulas, payment timing, and clawback policies, as well as treatment of discounts and returns.

Best Practices for OTE Implementation

Adopting best practices enables you to grow your team and business with an effective OTE structure. Here's how:

• Do Your Research: Review competitive OTE levels in your market and industry. Remember that your specific business model also affects appropriate ranges.

• Consider Your Sales Cycle: Monthly commission payments work for transactional sales. Quarterly payments may be best for enterprise deals. Whatever you choose, communicate the timing clearly during the hiring process.

• Stay Flexible: Markets change. Include annual review periods, and tie changes to clear business metrics.

• Monitor the Numbers: Track the percentage of reps achieving 75% and 100% or more of quota. These distributions reveal whether your OTE remains realistic and motivating.

• Stay Compliant: Automated systems reduce your administrative burden while ensuring accurate tax withholding on variable payments.

• Keep it Transparent: Clear documentation and communication are key.

Optimizing Your Compensation Strategy With Justworks

Successfully implementing on-target earnings requires balancing competitive packages with sustainable business economics. Modern HR platforms streamline OTE administration by automating calculations and providing transparent reporting. They also offer seamless integrations with your existing sales tools.

Justworks PEO provides user-friendly payroll software and HR solutions for small businesses. The platform handles the complexity of variable pay processing and multi-state tax compliance, letting you focus on building winning sales teams. Get started with Justworks today.