There are ten basic traps that business families can fall into when making compensation decisions. These traps can cause the individuals controlling compensation—most often the parents —to generate feelings of unfairness and family disharmony. In most cases, this happens unintentionally; few business leaders realize what they are doing is unfair.
Consider this situation: A child working in the business goes to the parent to discuss his or her “needs.” The parent often assists in fulfilling the “need” by raising the individual’s compensation. The trap is set! Other family members working in the business, usually siblings of the child whose pay was raised, learn about the increase. Next comes something we like to call the “slow internal burn.” Siblings discuss the situation among themselves, generating feelings of resentment toward the parents and distain toward the sibling receiving what is perceived as unfair compensation.
The siblings believe they are being penalized for being better organized, better money managers or less frivolous than the “in need” child. The trap has sprung. Soon enough, the spouses become involved. These are the people who know the number of hours and the dedication their significant others give to the business. They have joined the others in the trap and have also developed feelings of unfairness and disharmony.
Everyone is on the defensive, and it is usually most obvious at family functions. Conversations are strained and there is little interaction among family members. Unfortunately, the issue is rarely discussed until everyone in the family is at the breaking point.
The challenges of family compensation
Here are the ten traps, along with suggestions for avoiding them. Use this list as a guide to save you and your family from heartache and unnecessary conflict.
1. Compensation based on family status rather than on an individual’s contribution to the business. For example, the parents rationalize that because John lives at home, he does not need as much money as Joe, who is married, even though John has a more responsible position. The question that should guide compensation decisions: “What is each job really worth in the marketplace?”
2. Highly inflated paychecks as a means of saving on taxes. Paying higher wages to family members in an attempt to gain a savings on taxes, dividends, etc., is a practice that builds an “I deserve it” mentality. This can create more family conflict and a cash crunch in “lean” times. Remember: “Don’t create an entitlement attitude.”
3. Assuming your pay decisions will be OK with all family members. Set pay policies to avoid mistrust of your decisions and conflict between family members who believe you are “playing favorites.” Getting other people who are trusted by all family members working in the business involved in the pay policies will go a long way toward adding credibility to the process. Placing these policies in a “Family Policy Manual” can be helpful as well. Consider these questions: “Should you be the only one making the pay decisions? Could a board help? Would it be wise to involve other trusted advisers in this process?”
4. Letting wages for managers and dividends for owners be mixed. There must be a separation between pay for those working in the business and distributions to shareholders. Managers as shareholders should receive the appropriate wage for their position plus a return for being a shareholder of the company. A performance bonus for meeting certain goals set by the shareholders should also be considered. Remuneration for employees’ contributions should not be mixed with what they could receive as shareholders. Remember: “Fair is not always equal.”
5. Letting the finances of the company and/or how much Dad and Mom make be a secret. Many adult children do not understand the career opportunities they could attain because they do not know the financial reward the company can create. “I don’t want to go into the family business because I have watched how hard Mom and Dad work and I don’t believe they have ever made a lot of money.” Too often the senior generation in a family business does not take the time to lay out the realistic opportunities for financial rewards and career growth for the next generation. Question: “How can adult children make a career choice when they don’t know the opportunities?”
6. Emotional issues and threat of conflict used to determine pay. This leads to giving raises in order to avoid conflict or to get other family members “off my back.” A very natural tendency of a family is to strive to avoid conflict (even though some families will say the opposite is true). Using money as a way to achieve harmony never works. Remember: “Avoidance of conflict only adds to it.”
7. Not regularly or formally discussing individual performance expectations and results with each family member. When this is not done, family members do not know if they are being properly judged when raises and bonuses are distributed. Does everyone in the family business really understand what is expected of him? Evaluations must be realistic, based on specific job criteria and put in writing. Remember: “When I am not told how I am doing, I must be doing great!” 9. Establishing “perks” to keep family members happy instead of being honest about their productivity and contributions to the company. Perks should go only to those people in the company who contribute to the success of the business. Giving a perk to one family member because “he hasn’t been to a hockey game in a while” is not a good policy. We are all for extra perks for family members, but they must be understood, controlled and earned. Remember: “ ‘He who makes the most noise gets what he wants’ is a bad policy!” 10. Setting a negative example by overpaying yourself. Set the rules and live by them. Remember: “Actions speak louder than words.” That doesn’t mean you don’t deserve the rewards of the company you built. It means keeping wages as clear and understandable as possible. If you don’t, the person in line to take over your position may perceive that she deserves the over-inflated wages you were paying yourself. This can cause a split with other family members who find the wage gap unfair. Owner equity withdrawals, quarterly distributions and other tools can be used to get money out of the company without corrupting the wage policy for family members. Create a written policy Making compensation decisions in a family business is never easy. Without a clearly written policy for family compensation, conflict will arise and family relationships will be strained or possibly destroyed. There also may be a tendency to withhold information affecting company decisions owing to a resentful “I am not getting paid for this” attitude. Put the right rules in place concerning compensation for your family members. Be sure each of the working family members understands how compensation is determined. Put your compensation plan in writing. Don’t let these traps befall your family and business. Avoid them by keeping your family in focus and your business on track. Jim and Ann Marie Kwaiser, family business consultants and speakers, are the principals of C.H.A.L.L.E.N.G.E.S. Inc. in Mercer, Pa. (www.challengesinc.com).