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Articles - Finances and Wealth in the Family Business

Compensation planning in a family business

Thursday, April 02, 1998




By Kathy J. Marshack, Ph.D., P.S.


For years Arnie looked forward to having his son and daughter join him in his publishing business. Arnie and his wife, Ilsa, had rebuilt the business after Arnie’s father lost everything due to some poor planning and miscalculating the marketplace. Even though the business went under when Arnie was in college, he could see the potential. He had a degree in marketing and knew the publishing business from the inside out. With Ilsa’s accounting background, they systematically restored the business to a healthy functioning. About the time that Arnie’s and Ilsa’s two children were off to college the business was in expansion mode and Arnie was counting on his son and daughter to help take the company into the twenty-first century. The children were eager to help out too. They were getting relevant degrees in college, had acquired internships at publishing houses back East, and upon graduation were ready to come home and learn the family business under Mom’s and Dad’s tutelage.

Arnie and Ilsa had laid the groundwork well for inviting their children into the family business. The kids had seen how hard their parents worked, but they weren’t ignored. The family always came first. Also Arnie and Ilsa involved the children in the business from the start. Even as toddlers, they played in the office. As older children, they helped out with odd projects and straightening up. They were familiar with all of the employees, who felt like one big extended family to them. In high school, the children tried their hands out with some of the professional work. Frequently the family business was a subject for a high school project. It was common knowledge and often discussed that both son and daughter were welcome to work in the family business after they completed college.

All seemed to be going as planned until the day came to discuss the employment agreement with each child. Never before had the family had to consider real business when dealing with each other. As teenagers, the kids had been paid minimum wage or a bit better. There were no benefits or perks because their parents took care of those things. Now the children were adults, responsible for their own lives, which meant that negotiating compensation had to be strictly business. The children couldn’t be expected to work for minimum wage anymore and they expected to be compensated for contributions they made to the company. Arnie and Ilsa had some work cut out for them.

The question was, How to compensate their children, as if they were regular employees, but with the added benefit of having trusted family members to help run the business? Compensating relatives is a sticky business. Not all people are really created equal. It is sometimes very difficult to assess and compare the talents of family members who are also employees. Nor do all family members contribute equally to the business. As a result of the stress that this causes, many family business owners ignore the problem and let compensation become a breeding ground for dissension in the family. For example, many wives in family businesses do not earn a salary at all. The reason given by the CEO for this is that it saves on taxes. The justification is that she is an owner of the business, so she is growing an investment. However, the research also shows that family business wives are invisible when it comes to decision making and that they feel isolated and unappreciated. Lack of a salary or a nominal salary may account for this.

A recent survey by Mass Mutual Insurance Company reports a wide discrepancy between the salaries of sons and the salaries of daughters in family businesses across America. On average the typical son in a family business earns $115,000, while his sister earns only $19,000. These salaries also reflect the tendency of family firms to view the contributions of women as of less value and the strength of primogeniture in succession planning. In other words sons are groomed for leadership while daughters are groomed for supportive roles and paid less than their brothers.

In other situations, CEOs of family firms attempt to avoid the problem of compensation for family member/employees by paying everyone the same, even themselves. Or they hire a family member simply because they are family, regardless of their abilities. The problem with this method is that the talented and creative employees are not rewarded for their work and may become resentful of the family members they must "carry." And the employees who are overpaid are not getting accurate feedback for their work performance, which makes it hard to improve. Likewise the CEO is not really viewed as sacrificing when he or she takes a low salary. Rather he or she is viewed as a weak leader.

Although it is not easy to put aside the anxiety caused by developing a fair compensation plan for your family members/employees, it is absolutely necessary if business is to thrive. Family relationships built upon honesty are far superior to the games required by compensation plans designed to avoid friction. So if you follow the advice of experts you will design your compensation plan according to these five steps:

  1. Write up accurate job descriptions for each employee. Include responsibilities, level of authority, technical skills, level of experience and education required for each job.
  2. Identify what your compensation philosophy is. Do you want to pay about average, or higher? Do you want to attract talent from other companies? Do you want to offset the typical male/female wage differential? Are you a training ground for young, inexperienced people?
  3. Gather information on the salaries of similar positions in your industry. Size up companies that are similar to yours in number of employees, revenue, product, geographic location, etc. What salaries and other benefits do these similar organizations pay their employees?
  4. Develop a succession plan. How will a successor to the leadership be identified among family member/employees? How will they be prepared for leadership? How will this choice affect the morale of the family/business? How will this successor be compensated?
  5. Design an affordable plan. Obviously you want to do the best you can with the dollars you have. What can you afford to compensate each family member/employee relative to their contribution?

After you have a compensation plan that reflects the family’s values as well as sound business practices, you are in position to negotiate an employment contract with a family member. It is important that everything is spelled out up front so that when you have an annual review, there is a way to compare employee performance with outlined expectations in the job description. Salary increases can then be based upon the employee’s true accomplishments.

It will be hard for Ilsa and Arnie to totally separate their love for their children from this matter-of-fact compensation plan. There is room in any business for discretion in awarding raises and other forms of compensation. However, when the money decisions are made strictly from emotion or avoidance of emotion, there is bound to be trouble. As the CEO of a family business, make the best decision you can for the business. As a parent or a spouse, encourage your family member/employee to achieve their greatest potential within or outside the business. In this way both business and family wins.