Compensation Issues with Next-Generation Leadership
By Henry Hucheson
How to determine which child earns what, how to avoid hurt feelings, how to transcend parental perspectives in coming up with a fair plan, how to help lower earners advance to earn more long-term
Some family businesses succeed. Some fizzle out. Others go out with a loud bang. We have all heard of the family businesses that didn’t make it. Something went wrong; trust broke down, relationships started to fracture, and in the worst case, lawsuits broke out.
There are a variety of possible reasons, but one of the typical reasons is money. When money is involved some people’s behavior can go sideways. When there is a lot of money, some people turn into Mr. Hyde. Sadly, money is a big contributor to family business failures, broken families, and unhappy Thanksgivings.
Money can be very seductive. I had the opportunity to present to the Tulane Family Business Center, and the topic decided upon for the three hour workshop was the “Effects of Wealth on the Family Business.” Those who work with family businesses are aware of the power money can have in ripping apart a family business.
Nonetheless, money is certainly required and beneficial in life, but only to a point. At the bottom end of Maslow’s hierarchy money can buy you a lot of food, shelter, and security. But moving up the scale, not only does money become less important, it can be a hindrance to developing true love, self-esteem, and self-actualization.
Ted Klontz, Ph.D specializes in the effects money has on the psyche. In his presentations he asks a few folks to count a stack of dollar bills. Afterwards he informs them that the mere act of counting money increases the level of oxytocin in bodythe “feel good” hormone. Conversely, he will stand in front of the audience, whip out a $20 bill, say “watch this,” and proceed to tear it in half. The audience is always in shock, with some people gasping. (Note: it is a fake $20.) His point is to demonstrate that people feel actual pain when seeing money destroyed.
To make matters worse, people view salary as a gauge, rightly or wrongly, on not only their worth to a company, but as a barometer of how successful you are in life. This is why compensation in the family business is so trickyit’s deeper than just the money.
“Son, why don’t you come work for the family business? I am not going to run it forever, and then you can have it. And being a business owner can be a lucrative opportunity.” This is the first step of dad falling into the family business compensation trap.
“Dad, I really need a new truck, and if we get this nice new one then it won’t have problems, will last longer, and will be under warranty.” Dad rationalizes this request and concedes. Question: would he have done it for a regular employee at the same level? Overcompensating can also creep in unintentionally.
Many family business owners have a hard time paying their children actual market value. Gifts and kind-hearted parental assistance get mixed up with salary. And then keeping equality among the children gets trickier. If the compensation does not 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 where all four of the second-generation children, who were each 25% owners, were paid the exact same salary. This seemed odd as there was a president, vice-president, a salesman, and a drafting person. Clearly, those in an executive position should be compensated at a higher level than a drafting person or a sales person. This created enormous tension. How can you cut the salary of the lower level family members and have them remain happy? And how to you increase the salary of the executives without the others feeling cheated?
How did this come about? Their parents did not want to deal with the potential emotions that come from having to explain to one child why they don’t make as much money as their other sibling.
Start Right from the Beginning
It is easy to see how family businesses slide into a compensation problem. If dad is trying to lure children into the business, he overpays them. Makes sense, if junior is getting paid more at the family business than elsewhere, then he’ll stay long enough that it will eventually grow on him. Here is 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 can start.
Once the kids are in the business, and you overpaid them to start, years pass by and you realize they are getting paid more than they should. How do you explain that their raise will be so low? Worse, what if it gets so out of whack that you need to lower it? Then the next child comes into the business, you are now forced to treat them the same way as their sibling when they entered the business. Otherwise you have some explaining to do. 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, there 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 you sibling’s anyhow. In the meantime, it is 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, it is important to understand that it needs to be a professional relationship. The business will pay you what you are worth to the business. Just like any other business.
As you become more valuable to the business, it will pay you more. It is possible that one day you may run and own the business, but that is only if you are the best one to run it. You have brothers and sisters. They are welcome to join the business if there is a need, and they have interest and some skill. It is important to understand that all the kids will be paid differently, just as any employee is paid differently.
It is also important to keep in mind that there are important non-family employees. How would they feel if one or more of the family members made a salary more than they were contributing? What if they decided to leave? Now we have hindered the ability of the business to generate a profit.
Wonderful, but how is it that I can get my child to join the business if I am painting such a bleak picture? Simple, they need to understand that because they are your child, they will eventually be owners of the business, whether they join the business or not. If they are not in the business, the business would be sold. But if they did have an interest in owning the business, here is their chance.
On an ongoing basis, the best way to handle compensation is to not handle it: either have high level managers determine salaries, get the advice of an HR professional, or simply look on one of many salary sites to get a gauge on what an appropriate salary would be. You are a business owner. It is one of the most multi-faceted professions anyone can have. As a family business owner, if you were to pick and choose which areas you would be best at, compensation would not make the list. So get some help.
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, they 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 or intermingled with pay for performance at work.
Family business compensation is one of the most difficult areas to get straight. But if you can 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 you are off to a good start.
Henry Hucheson is president of Family Business USA. Contact him at firstname.lastname@example.org, (919) 741-1943, or (877) 609-1918
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