What is a referral fee? And how can it help your business grow? In the meantime, how much will a referral fee cost your business anyway? These are common questions from businesses that are considering starting a referral program.
Learn the best practices associated with referral fees and more, and how these aspects can help your business thrive.
What is a referral fee?
A referral fee is a commission that’s paid to the person who brings in a new customer to your business. Consider it a finder’s fee that works as an incentive for their time and efforts. The fee is paid by your business, coming from a portion of the new business earned. Usually, the referral fee is paid for closed business, however, it can also be paid for new leads.
Giving a referral fee is a great way to reward loyal customers, as well as those who consistently bring in new and/or high-quality customers. Usually, these people have connections or skills that your business wouldn’t otherwise have. Therefore, you want to show your appreciation for what these folks bring to the table.
Think about a time when you needed another person’s connections. For instance, when looking for a new house, you might reach out to a real estate agent and ask them for leads on properties that haven’t yet been listed. They will know people to ask, whereas you wouldn’t find the same leads that they drum up on your own.
Referral fees are similar to finder’s fees, but they are used in any industry, not just real estate. Yes, real estate referral fees are a big perk in the industry, but real estate settlements aren’t the only ones cashing in on this best practice.
As a company, you can offer to pay those who bring in regular leads, such as brand ambassadors or super fans. Essentially, they’re getting a commission for their work; many people earn a living this way, and those who are the most successful continue to earn. Giving them a referral fee or a finder’s fee keeps them motivated to keep sending leads your way. It’s also an effective way to say, “Thanks for all you do.”
In most cases, you’re dealing with skilled salespersons, brand advocates who successfully grow your brand, especially to populations that you couldn’t have reached on your own. Consider a system where a referral fee is paid to help this program grow.
Why should I use a referral fee?
At this point, you’re likely wondering why you should trust the use of referral fees. And there’s a simple answer: traditional advertising doesn’t work like it used to. Fewer consumers trust or rely on print ads, meaning it simply isn’t a viable way to reach a new customer base. Meanwhile, digital ads can be ignored or even blocked altogether with ad-blocking software. And if you aren’t reaching any customers, that’s an expensive bill to foot without gaining any leads.
Instead, consumers are relying on more meaningful connections, such as a one-on-one referral, or an influencer who can explain how a company works. If a person already follows and trusts an influencer, they are more likely to trust their judgment, possibly even signing up with a new brand because of them. Below, we’ll cover how you can use referral fees to generate more sales and grow your brand.
Are referral fees legal?
This is a common question among people looking to use referral fees, and the answer is that it depends on your industry. There are nuances in everything, and it’s important to check within your legal limits. But many companies are able to offer referral fees within legal limits. If you work within a template that suits your industry, you can also better stay within legal limits, especially with a real estate transaction.
Will referral fees work for my business?
Companies who use referral fees agree across the board that it’s a viable way to grow their business. In fact, they swear by them. Referral fees can vary by the type of business, allowing them to tap into clients that might otherwise be hard – if not impossible – to reach.
For instance, if there’s someone that has an entire network of people who would be perfect for your business, that’s a great lead for your brand. If you bring them onto your team, then pay a percentage of the income they draw in, you’re only profiting in the process. The referral fee is a small drop in the bucket of new business.
However, you need to see if a referral model is likely to be a good addition to your brand. For instance, if your company is not sought-after, or if your company has generated negative buzz, the business model will be unlikely to work.
Potential customers need to see you as something they want to join, or a product they want to try. There should be ample excitement surrounding the company so that people are excited to get involved. Then, with reward incentives to those who share, you can help further that buzz and enticement about becoming a customer.
Remember, if people aren’t excited about your company, a referral won’t work; new customers will be unlikely to sign up. And people simply won’t get involved to refer you. They have a reputation to protect, and this is done by sharing brands they trust and believe in. Sure there’s a payment involved, but even salespeople won’t risk losing their clients for a single payment.
Who pays a referral fee?
The product’s seller (you) will pay the referral fee to the person generating the lead. Or, in some cases, businesses pay a lead generation service, where instead of an individual salesperson, they pay a company who helped generate leads.
How to choose a referral fee amount for my business?
When setting up your referral program, it’s important to determine how much lead generators will earn as a referral fee. Before they get started, your influencers will want to know what’s on the table, and transparency can avoid any surprises later on.
The referral fee can be a flat fee or a percentage of the sale. However, there is usually not a set amount across the board. For instance, someone who brings in more leads might make more than a person who brings in fewer leads. An influencer might agree to more money for signing a non-compete clause, etc. Know that fees will likely vary with each brand ambassador.
No matter what price you land upon, remember to be fair to all, including the referred customer. For instance, if the fees for your services are too high (your fees plus the referral fee), they will avoid signing up and will use a more affordable option instead.
What are the costs of doing business to you, the service provider?
Before setting prices for your customers, or listing a referral fee, you should look at the cost of doing business. Be sure to cover your costs, while remaining fair to all involved.
Look at how much it costs to:
- Manufacture your goods or products
- Upkeep with services – company overhead and expenses (if you’re a service-based industry)
- Market your business
- What are the existing commissions to salespeople? Will the referral fees replace your sales team? Or work on top of them?
- Once a sale is made, what’s the profit margin? How much does your team need to be involved in? What procedures act takes up time/profits?
If the fees are high for the above, it’s a good idea to consider a lower referral fee or a flat fee so you can remain profitable. In addition, consider that paying a referral fee to the referring agent and your sales team is an unnecessary way to reduce (or eliminate) your profits. Instead of paying out two forms of leads for a single sale, consider various types of reward, such as a referral program.
How long does the sales process take?
How long does it take for new sales to come in? From the time an influencer makes a new connection, to business closed, how much time – on average – takes place? Depending on the industry, this could take a few hours for ecommerce businesses, or up to several months with B2B referral programs and other businesses with long sales processes. For instance, real estate brokers don’t see the fastest turnaround times. A referral agent might have a big lead time before getting their referral fee percentage.
It’s a good idea to discuss these logistics with your sales team and have a clear payment plan in mind. You don’t want them upset when waiting on referral fees to come in if the process takes too long. Create a clear plan for when the customer transitions from the influencer over to your brand.
When and how does your business make a profit?
How does your company earn money? Are fees collected in one swoop? Or in installments? Do you provide a recurring service? Will your brand make a single payment – of any size – from a new customer? Or will it be recurring? What about refunds and/or cancellations? No matter the margins in play, create a model in which your company still earns money with each new client.
How should you determine referral fee schedules?
There are several options on how you can use referral fees to motivate your influencer audience. Decide what will provide the most value to your audience, including structures that:
- Pay higher amounts for their first referral (this is incredibly motivating for newbies
- Increasing earning power with more referrals brought in (either overall or within a certain time period)
- Contests where the most successful referrers get more by “winning” with the most referrals over a certain time period
Tax and legal implications with referral fees
It’s important to be aware of taxes that can be required of referral fees. If a referrer earns more than $600 from your company, they will have to pay taxes on the income earned. You, as the employer, will also have to get W-9 paperwork and issue a 1099. It’s worth noting, however, that if the influencer is a previous customer, you can also form the funds as a refund, discount, or rebate on funds already spent.
Remember, before you follow this route, it’s important to check the legalities of your industry. For instance, real estate, financial services, and automotive industries have additional laws that may thwart referral fees. However, realtors have their own way to pay referral fees. Being careful about the wording of “kickbacks,” etc. can also help get around these legalities.
Referral fee examples
There are two main types of referral fee structures: flat fees and percentages earned. Take a look at both to determine which fit will be best for your brand.
One study outlines referral fees in SaaS businesses, for example, looking at various fee percentages and comparing them against earnings. Jason Lemkin explains:
Referrers should earn “35-40% of first-year ACV (Annual Contract Value) if they bring you a closed, signed lead. It would cost you that much to acquire and close that lead yourself.”
Referrers should earn: “15-20% of first-year ACV if they bring you a true opportunity. i.e., if they do the marketing part, but not the sales part. 10% or so for a lead. Much more than this, without deep qualification of the lead, gets expensive.”
Meanwhile, in car sales, flat fees are often paid to referrers whose leads close a sale. Usually, fees sit around $100-$300. Because cars are not purchased regularly by people, they are not considered to be frequent sales. Due to this nature and thin profit margins, large percentage referral fees simply aren’t feasible. However, car dealerships still want to encourage leads and provide a monetary thank you to body shop or other referrers who sent business their way. It’s also a great motivator for the leads to continue.
Percentage structure example
This company offers a percentage of sales to go to their sales team.
Flat referral fee example
Sungevity gives cash rewards as a flat fee for referring customers. You don’t have to be a current customer in order to earn, and it’s also available to their employees. Their structure works like this:
Creating a referral fee agreement
Hosting a referral fee or a finder’s fee agreement is considered a binding document between you, the business owner, and the referrer, or the salesperson or influencer. This contract outlines fees that will be paid, on what schedule, and any additional expectations, from either party.
Remaining professional when interacting with your referrers also sets a good tone for your business. Put your best foot forward, and protect your business legally when exchanging funds.
Your agreement should include key points such as:
- What is expected of the referrer?
- What is considered to be a successful referral?
- What is the referral fee? Or how will it be determined?
- When and how will the referrer be paid?
Many industries have found immense success with a referral fee structure. By tapping into networks that are available to individuals, such as influencers or salespeople, even a brokerage, they can add growth to their business’ bottom line. Meanwhile, in paying a referral fee to the referring party, they encourage them to keep bringing in new leads, and adding to the company’s profits, and total sales price.
It’s important to ensure your business is a good fit. However, for businesses that create company buzz and remain highly sought-after, it can be a great way to grow.
Want a way to pay referral fees automatically and keep referrers happy? Check out referral software: our ultimate referral software guide will help you choose the right tool.