Family Business Written Compensation Plan

One of the most sensitive subjects in a family business is compensation. In fact, I have seen plenty of family businesses disrupted (and sometimes worse)over compensation issues. I often hear such phrases as:

 “You all are my kids and I am going to pay you an equal amount.”
 
“Since your sister just had a baby, I am going to be giving her a raise to help cover the additional expenses.”
 
“Your brother’s wife said they are going on another trip. I bet your father pays him more than you.”
 
“I have worked here for 20 years and get nothing, while he pays his son way more than me and he has only been here 5 years.”
 
These conversations take place in many family businesses and left unchecked can become toxic. So what is the right answer when it comes to family business compensation? How much should you pay your son? Should family members be paid more?
 
Don Levitt of Levitt Consulting states that much of this “compensation confusion” arises from role confusion: mixing up the roles of employee, shareholder, and family member. Compensation gets confusing when it is used as a tool for parenting (helping children who need more money; reducing sibling rivalry) or a tool to reward ownership (paying family member owners more than their jobs merit). These ideas seem appealing at first, and may work for a while, but they usually sow the seeds of future animosity and discontent.
 
What is compensation? Compensation is first and foremost a business tool. Something used to motivate employee performance and achieve strategic business goals. Family businesses which use compensation in this way find that both family member employees and non-family member employees can get excited about helping the business to grow and be successful.
 
This does not mean that a family business compensation plan needs to be rigidly tied to the market value of jobs as might be the case in a publicly-held company. Some family businesses may indeed decide to go this route and pay all family member employees at market value (with market value based on the complexity of the job and not just on the job title – because family member employees often receive titles far more grand than their actual jobs merit). Other family businesses may legitimately decide that all family members who are owners should be paid the same regardless of their job – to encourage a feeling of “partnership” and working together to grow the business and shareholder value.
 
Too often parents feel like unequal pay means unequal love. Last year I wrote a blog post titled, Does Fair Mean Equal where I tried to address this fallacy. When it comes to paying our children in the business, I feel it is important to focus on being fair and just. Paying a market rate for performance. This often helps to avoid resentment among non-family employees and reduces the risk of nepotism and entitlement in your family and business.
 
I suggest that a family business replace the common “Founder Stage” seat-of-the-pants approach to compensating family members and instead employ a written compensation plan. This takes away the mystery and compensation unknowns among family members that often lead to conflicts.
 
A written compensation plan is something that needs to be discussed in family meetings to make certain that everyone understands the why and the how. If your family business has an outside board, I highly recommend you use them to help determine market compensation. This also has the added benefit of creating additional objectivity.
 
This is such a vital and key area that it is often recommended you seek some outside advice. If you would like to discuss with me further, please feel free to contact me.

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by Scott Heintzelman - Scott is a CPA, CMA and CFE living in Pennsylvania. Scott is a partner serving on the executive team at McKonly & Asbury LLP, a regional accounting firm with multiple offices in the Mid-Atlantic. The firm has been an IPA ALL-STAR as well as winning Best Places to Work in Pennsylvania for numerous years.

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