How to Track ARR & Quota Credit for Non-Standard Renewals and Expansion

Jeremey Donovan | March 14, 2022| 1 min. read

Determining annual recurring revenue (ARR) and quota credit is straightforward when every renewal has a standard twelve-month term. If a relationship expands from, say, $120K to $180K, then the total ARR is the new higher value, and the incremental ARR used for quota credit is $60K.

However, things get a bit more complicated when you throw in early or late renewals with or without expansion or contraction. The situation is even more complex when upsells are timed to align with the ends of existing contracts, i.e., timed to be co-terminus.

In this article, we explain how to handle a variety of non-standard yet not atypical upgrades. So that we are on common ground, let us assume an account manager (AM) sells a new contract on January 1, Year 1 for 100 users at $100/user/month. The ARR is thus $120K and the contract end date is December 31, Year 1. Further, assume the AM earns 10% on either new bookings or contract expansion; they earn 0% on flat or down renewals. Hence, the AM earns a $12K commission on the initial sale.

Scenario 1: Co-Terminus Upgrade Followed by Flat or Up Renewal

Imagine the client adds another 50 users on July 1, Year 1. The impact is as follows:

Total ARR: $180K
Incremental ARR: $60K
Client Billed: $30K
AM Commission: $6K

One might ask, “Shouldn’t Total ARR be $150K given that the upgrade is for $5K a month for 6 months?” Remember, the “A” in ARR is annual, so we must think about that total annual amount in force at a given time. We find it helpful to consider the total amount the AM will be on the hook to renew; in this case, a flat renewal would be for 150 users at $100/user/month. Or $180K.

Once we know the new total ARR, calculating the incremental ARR is trivial. Moreover, we only bill the client for the services to be rendered in the remaining six months.

(Technical side note: By including an “incremental ARR” field on every opportunity, the company can easily sum this field across all closed opportunities to get the company-wide ARR. This does require tracking downgrades and cancellations as well.)

The next logical question is, “Why not pay the AM $3K since we are only billing the client for $30K?” Recall, the salesperson earns 0% for a flat $180K renewal at the end of Year 1. We pay the AM $6K since they deserve to be compensated for the upgrade benefit the vendor earns in the first six months of Year 2. It is just easier to pay the AM upfront than to defer the payment. Paying early also provides a stronger upsell incentive.

Sure, there is a risk that the client will non-renew at the end of Year 1. The expectation value of the overpayment is the logo churn rate, typically around 15% in SaaS, times the $3K that was paid in anticipation of renewal. In this example, that amounts to $450 or just 0.75% of the $60K upgrade. At a fraction of 1%, it is just not worth the administrative headache and loss of AM motivation caused by holding the additional $3K back until after a successful renewal. That would be penny-wise pound-foolish.

Scenario 2: Co-Terminus Upgrade Followed by a Down Renewal or Cancellation

Let us build on the mid-contract, co-terminus upgrade but assume the client downgrades for their January 1, Year 2 contract from $180K to $144K, covering 120 users at $100/user/month. The impact is as follows:

Total ARR: $144K
Incremental ARR: -$36K
Client Billed: $0
AM Commission: $0 or -$1.8K

Here, the company has two policy options. The more aggressive policy is to claw back the extra $1.8K that was paid in anticipation of renewal. The kinder, gentler policy is to simply let bygones be bygones.

Anecdotally, companies are roughly evenly split on which policy they adopt. The main reasons to have the clawback are to ensure AMs are neither over-selling nor under-servicing their clients. In contrast, the main reason to avoid the clawback is that it is both difficult to explain and hard to administer at scale.

Why is the aggressive policy claw back $1.8K and not $3.6K? For the $60K upgrade, the company earned $30K in the last half of Year 1 for the incremental 50 users but only $12K in the first half of Year 2 for what is now only 20 additional users. So, the AM should be paid $4.2K, 10% of $42K. Since they were already paid $6K when they sold the upgrade in the middle of Year 1, the company claws back the over-payment of $1.8K. As one might imagine, it takes a very savvy sales finance team to enforce this policy.

Scenario 3: Standard Early Upgrade

Companies usually execute co-terminus upgrades during the first 9 months of a contract period and then switch over to standard early upgrades or to cancel-rewrite upgrades in the final 3 months. We discuss the former here and the latter in scenario 4.

Here, let us assume the client decides to upgrade from the 100-user, $120K contract to a 150-user, $180K contract on October 1, Year 1. What makes this a “standard” early upgrade is that the additional users get their licenses for the remaining 2 months of Year 1, but the renewal extends through December 31, Year 2. The impact is as follows:

Total ARR: $180K
Incremental ARR: $60K
Client Billed: $190K
AM Commission: $6K (with optional SPIFF up to $1K)

By now, the rationale for the Total ARR and incremental ARR should be clear.

The client is billed $190K inclusive of the $180K for 150 users in Year 2 plus $10K to cover the remaining 2 months of Year 1 for 50 users at $100/user/month.

Getting the $6K “bird-in-the-hand” is enough of an incentive for the AM, especially if they are already in accelerators. Most SaaS companies tend to pay commission on only the first year of new or expansion sales and give a SPIFF of up to the commission rate, typically lower, on billings over an extended-term; SPIFFs do not retire quota.

Scenario 4: Cancel-Rewrite Upgrade

Cancel-rewrite upgrades are so-called because they “cancel” the existing contract and rewrite it to modify the terms and conditions. Here, let us assume the client upgrades from the 100-user, $120K contract to a 150-user, $180K contract on October 1, Year 1. But, unlike in the standard early upgrade, the new contract end date is September 31, Year 2.

As one would imagine, vendors prefer standard early upgrades since they lock the customer in at a higher rate for a longer duration. That said, we have seen companies favor cancel-rewrites to improve linearity when contracts are jammed up at the ends of quarters or the end of the year. The impact is as follows:

Total ARR: $180K
Incremental ARR: $60K
Client Billed: $160K
AM Commission: $6K

Again, the total ARR and incremental ARR amounts should make sense.

The $160K billed to the client reflects $180K to cover the 12 months from October 31, Year 1 to September 31, Year 2 minus a credit of $20K for the “early-cancellation” of the original $120K contract. The $20K is 100 users at $100/month/user for 2 months.

While one could go down the path of clawing back (up to) $2K from the AM, we strongly recommend against this because the cancel-rewrite motion is, as alluded to above, typically initiated as a program by leadership to smooth bookings in future years.

Scenario 5: Contract Lapse Followed by an Upgrade

This scenario has less to do with the upgrade and more to do with how to handle temporary contract lapses.

AMs paid on new business and upgrades but with no penalty for cancellations might be tempted to game the system by allowing contracts to lapse only to renew them a brief time later. This is especially tempting since many companies will allow service to continue for a few months even after the contract expires as an act of goodwill in hopes of securing a “better late than never” renewal.

For this reason, we recommend vendors impose a rule that AMs are only eligible for quota credit for bookings in excess of a historical maximum ARR, typically looking back at least 6 and rarely more than 12 months.

Let us assume the AM fails to renew a 100-user, $120K contract signed on January 1, Year 1. Miraculously, with all intended sarcasm, the AM signs a “new” contract for $180K with the now ex-customer on March 1, Year 2. The ARR impact is spread over two time periods.

Vendors usually have a delay before recognizing renewal opportunities as closed lost. For this example, we will assume the grace period is one month such that the impact on February 1, Year 2 is:

Total ARR: $0
Incremental ARR: -$120K
Client Billed: $0
AM Commission: $0

Total ARR is $0 and requires no further explanation. We need the -$120K incremental ARR entry so that we can still sum across all closed opportunities and get the total company-wide ARR. The AM incurs no penalty or clawback since they are only paid on new business and expansion. On March 1, Year 2, the impact is:

Total ARR: $180
Incremental ARR: $180K
Client Billed: $180K
AM Commission: $60K

With the “high-watermark” rule in place, the AM is only eligible for commission on the $60K expansion.

Final Thoughts

While some of the above scenarios may seem esoteric, they arise more frequently as one’s business scales. With disciplined data collection, these upgrades are easier to tackle. Most critically, start tracking incremental ARR CRM opportunities.

Further, ensure your AM compensation plans are set up to handle these scenarios. Keep in mind – even small compensation incentives can have strong positive and negative impacts on a salesperson’s behavior.

If you’re wondering why an organization would encourage scenario 4, we’d encourage you to read “11 Ways to Improve B2B Sales Linearity," below.