Family firms must consider the role of compensation in the war for talent

By Wayne Cooper

Executive pay tactics are a potentially powerful set of tools for any business to use in recruiting, retaining, motivating and rewarding the key executives who are most responsible for sustaining and growing a business. However, there are important additional considerations for family-owned businesses.

Family companies must resolve two unique issues: (1) how to compensate family members in a way that is fair for the family executive as well as fair for other family owners who don't work in the business; and (2) how to create and maintain a compensation plan that is attractive to non-family executives you are trying to recruit, retain or motivate.

Compensating family members

Many family businesses have run into big problems when compensating family members—and, in some cases, the issue has destroyed businesses and families. There are many traps to avoid.

This risk is amplified when some family members work in the business and others do not. Family members who work in the business might feel they are undercompensated. On the other hand, family members not in the business might feel those in the business are overcompensated.

Family businesses that have successfully avoided problems share several best practices:

1. They use external independent compensation data to benchmark their family members' compensation packages against the practices of comparable companies in terms of size, industry, growth, profitability and geographic market.

2. They have explicit equity and pay philosophies that are clearly communicated to all family shareholders and employees. Some family companies allocate equity to all family members equally, regardless of whether they are in the business. Others allocate equity based on family members' involvement in the business. Either can work, but the equity philosophy should be communicated and understood up front to minimize the possibility of conflict.

3. In companies that do not award equity to family members based on their role and active involvement in the business, other compensation mechanisms (e.g., salaries, bonuses, benefits and perks) are used to compensate family employees competitively. Again, benchmarking to ensure fairness and objectivity is important.

4. Many large family enterprises have family councils that elect representatives to serve on the company's board of directors. The family council representative serves as the voice of the family shareholders who are not active in the business.

Compensating non-family members

Successful family companies also work hard to develop competitive compensation packages to attract and retain talented non-family members, but the track record among family businesses is mixed. According to the new CEO and Senior Executive Compensation Report for Private Companies, which gathered data from more than 1,300 private companies, the compensation for the CEO of the average family business is competitive with CEO pay for all privately owned companies—whether the chief executive is a family member or not.

However, many family firms don't pay their CEOs competitive compensation packages, particularly among companies with annual revenues in the $10 million to $100 million range. Beyond the CEO and chairman positions, the average family business is not compensating its executives competitively, the CEO and Senior Executive Compensation Report for Private Companies found.

Chairmen in family businesses were paid 32% more than their peers across all private ownership types, and family business CEOs made 99% of the median across all ownership types (virtual parity). But other senior executives in family businesses, on average, were paid less than their peers in other types of privately held companies.

This compensation gap between family-owned businesses and other privately held businesses is even more pronounced among select ownership types and job titles. For example, the median compensation for a CFO in a family-owned business was 41% less than the median compensation for a CFO in a private equity-owned company. The median pay for the head of R&D in a family-owned business was 37% less than the median pay for the head of R&D in a venture capital-owned company.

Although the median total pay package for CEOs in family-owned companies with revenues of $10 million to $99.9 million was competitive with other ownership types, top-quartile CEO total pay packages in private equity- and venture capital-owned companies in this size range were substantially higher than top-quartile CEO pay packages in family businesses. In companies with revenues exceeding $100 million, both the median and top-quartile total pay packages of family business CEOs were substantially less than at other types of privately owned companies.

The large gaps in median compensation packages indicate that most family businesses are not paying their senior executives (other than the chairman and CEO) competitively. These family firms are likely losing the war for executive talent. In order to attract and retain top performers in key positions, these companies must change their approach to executive compensation.

Here are some ideas to consider when developing your compensation philosophy and program:

1. Consider how your company's performance would improve if you had top-quartile executives in various executive roles, vs. average performers. For example, in a manufacturing or technology-based company, there is tremendous leverage in having a great head of R&D rather than an average player. In a company that is highly leveraged, a great CFO can more than pay for himself or herself. Family businesses should be willing to pay top-quartile compensation packages to recruit and retain stars in their key positions.

2. Create a pay philosophy that is consistent with your business strategy. You needn't have the highest guaranteed payments (e.g., salary, benefits and perquisites) and the highest variable compensation (bonuses and/or long-term incentives), but companies that beat their competitors in one of these dimensions tend to have an advantage in recruiting and retaining a segment of employees (either the risk-averse or the risk-takers). It's better to have an advantage with either segment than to be average across the board.

3. Benchmark your compensation packages to make sure they are competitive for new recruits as well as your existing employees. If your current employees feel they are undercompensated, hard feelings often fester, and by the time you find out about it, it's too late to turn them around. Use external benchmarks, or see if your association or chamber of commerce conducts an executive compensation study for your industry or local market.

4. Many closely held family businesses do not grant equity to key executives, because they want to keep ownership within the family. But there are other ways to compete with companies that use equity incentives. Some family firms use long-term bonus programs. Others create equity appreciation rights or other synthetic programs that mirror the incentive of stock options to reward employees for helping build the long-term equity value of the business without granting stock.

Wayne Cooper is the CEO of The Chief Executive Network, a peer network organization for CEOs and senior executives. He is the author of the CEO and Senior Executive Compensation Report for Private Companies (www.ChiefExecutive.net/compreport).

Copyright 2017 by Family Business Magazine. This article may not be posted online or reproduced in any form, including photocopy, without permission from the publisher. For reprint information, contact bwenger@familybusinessmagazine.com.

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March/April 2017

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