Pay may be the greatest source of friction in family firms. It is a terribly complex issue for the owner and his children working in the business.
- Government tax policy encourages parents to overpay their offspring;
- Parental perspectives motivate pay based on what is good for them or what they need;
- Entrepreneurial instinct is to be too frugal.
When establishing compensation policies, we believe family business owners need to ask themselves some important questions:
- How does the pay of a family member affect the pay of others in the organization?
- Does out-of-the-ordinary compensation encourage more secrecy in the company?
- Does too much pay create dependency and bad habits?
- Does too little pay drive away the best qualified family members?
- Are the income and estate tax savings really worth all the ambiguity and misunderstanding?
The answer seems too simple: Pay family what the job is worth. If you want to otherwise enhance their standard of living or reduce your estate taxes, do through gifting — private, out-of-the-business gifting is preferred.
In family businesses, it is often the message, not the money, that is important. To keep the message clear, we suggest thinking of family remuneration in four parts:
- A salary or wage for the job based on its market value.
- A performance bonus for meeting certain personal objectives.
- A profit distribution (dividend or bonus) based on company profitability to reward ownership.
- A parental gift to loved offspring.
The key is to define each part for family members, however the dollars are paid out.
Most parents get in trouble when their motives are confused and they compound the error by attempting to obfuscate the facts. We know too many parents who underpay children in order to convey a parental lesson or control their lifestyle. We know too many parents who overpay offspring in order to buy dependency and/or spoil the grandchildren.
Not wanting to recognize or admit either intent, they construct an ambiguous pay rationale. As compensation levels become less justifiable or more arbitrary, pressures increase to keep information secret from other family members and employees in the organization.
We find the results are almost always unfortunate in the long run. Values and trust are compromised.
Two fundamental principles of family business offer a lot of help when considering family pay:
- Separate your thinking and actions into three categories: What’s appropriate as a manager/employee? What’s appropriate as an owner? What’s appropriate as a family member?
- Make communications and expectations unequivocally clear.