Compensation in the Family Business

Family-owned businesses are the backbone of our economy.

Are you the owner of a successful family business? If so, let me congratulate you!

Family-owned businesses are the backbone of our economy. They tend to last longer and perform better, owners are more positive about the future, and employees tend to have higher levels of engagement. That said, family businesses are not without their own unique challenges, especially when attempting to navigate the integration of successive generations.

One challenge that can arise is in the realm of compensation. Are individuals paid based on their position in the family, percentage of ownership, personal financial circumstances, or for the role and contribution they bring to the business? The way you approach this matter can have a significant impact on the way family members participate in the business and in the family.

Let’s discuss some common dynamics around compensation in the family business.

• Sometimes, family members are paid less than the market rate for their role in the business. This can be driven by the sense that family members should sacrifice personal interests to serve the interests of the family at large. This can certainly help the business weather through tougher times better than their non-family competitors, and this can be okay if everyone is on the same page and all share equitably in the value the business produces. However, when dividends are distributed differently than the work it takes to create them, those taking a hit on their paycheque may find their resentment growing toward shareholders or other family members not making the same sacrifice. 
  
• Another reason for paying less is that first generation entrepreneurs can see a lot of value in their children struggling through their early years like they did. This may be true, but they must realize that if their children aren’t also building value in an asset they own, they might not have the same incentive to endure these struggles as the founders did.
  
• In other cases, family members might be paid more than the market rate. Sometimes, this is done to incent them to join the family business. Maybe they live far away, or maybe they already have great career prospects of their own. Or maybe they are afraid of certain challenges they see working in the family business and would rather keep family and career separate. Whatever the reason, if you are having to offer a premium to get family to work in the business, it is wise to understand the root of the problem before bringing someone in. If fair pay and future opportunity is not sufficient motivation for someone to work in the family business, you’ll want to think twice before striking a deal that wins them over in the short term.

Sometimes, employment and compensation are used as a misplaced tool for bringing “distributive justice” with respect to the family’s wealth. Leadership roles and salaries can be handed out to children more as an effort to keep things fair and maintain the peace than doing what is best for the business. Parents may provide jobs and compensation to children because they are trying to help them out financially or to help them escape the challenge of making it on their own. Unfortunately, these tactics can result in unintended risks for both the business and family relationships.

You can save yourself some trouble by creating a clear compensation plan with clearly defined roles and responsibilities, compensation packages benchmarked to the market and kept current, open communication, and regular review of performance.

If you are struggling with compensation or other challenges in your family business, I can help. You can reach me at jeff@covenant.ca.