How to Manage the Unique Compensation Challenges of a Family Business
Last month we discussed the causes that make the management of compensation in family-owned and operated businesses different and potentially more difficult and challenging than in other businesses. These factors almost always lead to trouble unless recognized and addressed.
In response, Wilkening & Company has developed four (4) principles for the effective management of pay in family-owned and operated businesses. By using these principles, we believe that the problems discussed in our August issue can be avoided. Let’s review each.
- Know what you mean when you say “pay or compensation.” The definition of “pay or compensation” is quite simply: salary and cash bonuses. Do not be drawn into a discussion over whether your sibling’s ownership-based distribution (or draw) or country-club membership is compensation. They are not! But in family businesses both pay and non-pay cash distributions are freely mixed all of the time, and vociferously debated. Why is this important? Stick around for a minute for principle #2.
- Know the facts. If you want to evaluate a sibling’s pay or compensation, use the tried & true method of comparing it to the market for similar jobs and businesses as reported in pay data surveys. Compensation data from these sources primarily represents salaries and annual bonuses or incentives. Ownership or non-cash distributions (like benefits or perquisites) are not collected nor reported.
When using any survey, make sure the data you use is reliable, fairly (independently) collected and based upon enough observations or data points to make the use of statistical terms like “median” possible and meaningful. Generally using the comments of your next door neighbor or a job-search website (or similar sources) for your data is highly suspect. So if you think someone is paid too much, see what other companies have actually reported paying (in salary and bonus) for the same job. Know the facts.
- Be transparent. Transparency is a term thrown around freely in the arena of politics these days, where it means little or nothing. But, what does it mean in the arena of family compensation? It is generally known that by the time a family-owned and operated business reaches its 4th generation, there can be as many as 30+ participants involved in the affairs of the company by right of ownership, marriage or future succession. These participants are often called stakeholders. And, each will likely have an opinion regarding compensation and other operating matters, and many are not shy about stating same. To assure that these opinions are based upon facts and not reactions to a data surprise (e.g.: “I did not know Uncle Jerry made $200,000 last year!”), be sure key family stakeholders know all of the information they need to know about family-member (and other key executive) pay within the enterprise.
Publically-owned companies routinely publish key officer, director and other executive compensation data to all (or select) shareholders each year in a “proxy” statement. Take the same approach with your stakeholders and publish your own annual proxy statement for limited distribution. But remember to remind the reader that this is strictly privileged information and may represent a competitive advantage. Being a stakeholder goes beyond just having opinions, and has its responsibilities.
- Define fairness.It is well known that an individual’s perception of fairness is primarily determined by their own reference or perspective. For example:
- “If I make $50,000 a year in my job, $550,000 paid to our company’s CEO (my cousin) is unfair.”
- “If we need to spend $4 Million in capital next year, $550,000 paid to the CEO (still my cousin) is unfair?”
- “If the banker next door made $1,135,000 Million last year, my paltry $550,000 is unfair!”
- “Aunt Mary Beth told me you make too much money, and it is unfair.”
In the end, “fairness” depends on where you are standing. And, your ability to influence perceptions or opinions (once made) is limited. So, actively influence perceptions of fairness before the fact. How? First (and of course), consistently apply the first three principles above. But even go a step further. Define what the company considers as fair through the select disclosure of company pay data and its accompanying market analysis to key stakeholders and opinion leaders. Some may disagree, but everyone will understand the scope and terms of the debate. And, the benchmark for fairness will surely have been established.
Compensation can be a perplexing and time-consuming subject within the family-owned and operated business. As you can see above we believe that if a company follows some simple and easily-implemented principles, family members can avoid common family-compensation pitfalls and free up time otherwise consumed with this often contentious subject. With that extra time available, the family can now focus its efforts on growing the business—and ultimately creating new 24-karat pay problems for the future.
If you have read the above and you are not part of a family-owned and operated business, try applying the 4 principles within your business and with your Board. I am sure these principles are just as valid. Try it.
Wilkening & Company has advised family-owned businesses on matters of private and family-company compensation for over 3 decades. In addition to compensation, we also have experience with family-business succession, organizational effectiveness and Boards of Directors. If you have questions or challenges, call us at (847) 823-5090, or write at email@example.com.