Proceed With Caution: Compensation Issues Can Be Sticky

By: Henry Hutcheson

From: IGC Retailer, November/December, 2013

Proceed With Caution: Compensation Issues Can Be Sticky
Weíve all heard of the family businesses that didnít make it. While some succeed, others fizzle out or end in disaster. Somewhere along the line, something goes wrong - trust breaks down, relationships start to fracture, and in the worst cases, lawsuits break out. There are a variety of reasons why, but one of the typical culprits is money; it can be very seductive, and it can rip apart a family and a family business.

Mind Over Money
One of the pitfalls in family business lies in compensation. Itís deeper than just money. People view salary as a gauge, rightly or wrongly, of not only their worth to a company, but of how successful they are in life. To continue the legacy, business owners often offer more to the second generation than is feasible.

ďSon, why donít you come work at the garden center? Iím not going to run it forever, and then you can have it. Being a business owner can be a lucrative opportunity.Ē This is the first step of dad falling into the family business compensation trap.
ďDad, I really need a new truck, and if we get this new one, it wonít have problems, will last longer and will be under warranty.Ē Dad rationalizes this request and concedes. Would he have done it for a regular employee at the same level? Overcompensating can creep in unintentionally.

This isnít the only way family business owners have a hard time paying their children actual market value. Gifts and kindhearted parental assistance get mixed up with salary, and keeping equality among the children gets tricky. If the compensation doesnít end up out of whack for some members, then it ends up out of alignment in the other direction when everyone is blindly paid the same.

We had a client a while back whose four children, each 25 percent owners, were paid the exact same salary. This seemed odd, as there was a president, vice president, salesperson and drafting person. Clearly, those in executive positions should be compensated at a higher level than a drafting person or a salesperson. This situation created enormous tension, and it came about because the parents didnít want to deal with the emotions that come from having to explain to one child why they donít make as much money as his or her sibling.

Start on the Right Footing
Itís easy to see how family businesses can slide into compensation problems if dad is trying to lure children into the business by overpaying them. It makes sense that if junior is getting paid more at the garden center than elsewhere, heíll stay long enough, and it will eventually grow on him.

Hereís the issue: As my professor Bob Bontempo at Columbia Business School told us many years ago, the key to negotiating a salary is your starting salary. Every year, you will get a raise, and with compounded interest over time, you can be making serious money. It all depends on how high you start.

Once youíve overpaid the kids to start in the garden center business, years may pass before you realize theyíre getting paid more than they should. How do you explain that their raise will be so low? Then, when the next child comes into the business, you are forced to treat them the same way as their sibling, otherwise you will have some explaining to do. The bottom line is, resist the temptation to buy your kids into the business.

The best answer is to communicate the situation to them from the beginning:

Son/Daughter, this is a business, and I own it. I would love for you to be a part of it. There are many benefits to owning and running your own business. There are also downsides. At the end of the day, when I pass away, the business will be yours and your siblingsí anyhow. In the meantime, itís a machine that generates money for the family. We must all ensure that the machine is working well. If you have interest and skill, then you could be a part of the business. However, itís important to understand that it needs to be a professional relationship. The business will pay you what you are worth to the business.  

As you become more valuable to the business, it will pay you more. Itís possible that one day you may run and own the business, but thatís only if you are the best one to run it. You have brothers and sisters. They are welcome to join the business if thereís a need, and they have interest and some skill. Itís important to understand that all the kids will be paid differently, just as any employee is paid differently.

They need to understand that because they are your children, they will eventually be owners of the business, whether they join the business or not. If they arenít in the business, the business would be sold. But if they have an interest in continuing the business, hereís their chance.

On an ongoing basis, the best way to handle compensation is to not handle it. Have a high-level manager determine salaries, get the advice of an HR professional or simply look on one of many salary sites to gauge what an appropriate salary would be.  

Now, with all of this said, when the company makes a profit, the owners can retain that profit for their own desires. And just as any family would do, parents can give financial gifts to their children. But it should be made clear that this money has nothing to do with being in the business and should not be confused with pay for performance at work.

Family business compensation is one of the most difficult areas to get straight. If you communicate from the start that the most important thing for the family is to have the company run well, and that your love for your kids is not affected by how much money they make or what position they have, in or outside the family business, then youíre off to a good start.  

Download Article as PDF