Institute For Family Business
                


      Kent Lutz- Advisors To Families In Business
Family Business Compensation

    Common Causes of Family Business Compensation Problems

 

Role Confusion: Confusing payouts to family members in their roles as owners or loved ones with compensation for performing a job in the business.

 

Using Pay to Achieve Tax Savings: Using high salaries, perks or phantom jobs to transfer tax deductible wealth to family members and avoid the heavy taxes imposed on dividends or gifts.

 

Using Pay to Maintain Parental Control: Using paychecks to convey messages or accomplish goals that have nothing to do with market value of the job performed such as luring reluctant children to work in the business or pressuring offspring to learn the importance of frugality.

 

Using Pay to Resolve Emotional Issues: Providing extra pay to ease uncomfortable feelings such as parental guilt or resentment among offspring.

 

Preserving Secrecy at All Costs: Assuming that is always indiscreet, impolite, or just plain  wrong to talk about how people working in the business are paid.

 

Confusing Business and Personal Funds: Assuming you can draw as much compensation from the business for as long as you need it to support the retirement lifestyle of your choice.

 

Taking Relationships for Granted: Assuming family members will trust, respect and be

satisfied with your pay decisions just because they are family members.

 

Using Salary Substitutes: Offering titles, perks or other salary substitutes to appease

family members unhappy with their pay.

 

Paying Everyone Too Little-Or Too Much: Holding down top management pay as a

suppressing compensation throughout the organization or conversely, raising pay too

high to retain people and avoid having to tell longtime employees how they are doing.

 

Using Pay to Smooth Ups and Downs: Altering pay to soften the impact on employees 

ups and downs in the business, paying more in lean times to prove that you are great boss

paying less in good times because there is no need to prove anything then.

 

Kent Lutz

Founder

Institute for Family Business

Advisors to Families in Business

Assistant Professor, Business

University of Cincinnati

Blue Ash College

513-314-7561

kent@thelutzinstitute.com

                      Steps In Building A Compensation Plan

 

  1. Decide on philosophy of compensation, including whether to pay family members equal amounts or based on the market value of their jobs.
  2. Determine the market value for particular jobs.
  3. Consider whether you want pay to be set at the market average or whether you want to make a culture statement with pay at levels above or below the market average.
  4. Adjust pay to reflect qualitative characteristics of the job that make it more or less strategically important than one would assume based solely upon market value. Such qualities might include leadership capabilities, communication skills or analytical skills.
  5. Decide if you also want to offer an annual incentive plan based on personal goals and/or company performance., or perhaps a combination of both.
  6. Negotiate personal goals and pay incentives for individuals and/or teams.
  7. Establish classifications and criteria for assessing company performance.
  8. Consider whether you want to have a long term incentive plan.
  9. If so, establish the criteria (i.e., book value increases) and classifications (i.e.,

increase book value 15%) for long term incentives.

 

  1. Communicate clearly to everyone the philosophy of compensation and your 

plan to review and possibly refine it each year.     

 

 

           Common Compensation Trouble Spots

 

The entry of younger children into the business. If discrepancies among children paychecks are too great, parents may have to explain why.

 

The advent of the first generation of family stockholders who are not working in the business. These family members may question or resent other’s pay.

 

The desire to recruit a highly qualified or experienced family member from outside the business. Pay decisions on this recruit may seem to insiders to break the mold , raising questions of resentment.

 

A decision to try to attract non family managers. This raises questions about compensation, perks, incentives and stock ownership.

 

The retirement of a business owner who continues to draw a paycheck. Successors frustration over their inability to control payroll costs can lead them to try to rope the ex-CEO into compensation planning.

 

An entrepreneurship’s frustration that employees expect routine annual pay raises regardless of the business’s profits. This often sparks a plan to tie pay more closely to company performance.

 

A change in the nature of the business . Examples: a shift to a team sales approach from one that emphasizes individual superstars, or the emergence of low paid customer service people, rather than salespeople, as critical to the company’s growth.

 

 

               Additional Thoughts On Compensation

 

A good compensation plan should keep everyone involved in the business working for what is best for all-a common mission and vision.

 

A philosophy of compensation is really a summation of the values, goals, and principles held by the family that guide all decisions about salary, benefits, and perks. By having a philosophy, it relieves decision makers of the burden of developing, for each employee, (family or non family) an individual compensation package. An example of a “Family Business Compensation Philosophy” might include: Will you compare pay and performance levels with those businesses you compete with? Would your goal be to provide total compensation between the median and 75th percentile of comparable groups? Do you want to emphasize performance based incentives at the expense of base salary? Will base salary be held at or below the median level for comparable groups? Will individual salaries be held within 20 percent of the mid point for our comparison groups salary range? Will your annual incentives exceed those of comparably sized competitors? Will long term incentives, if you have them, be based on increase of shareholder value? Should compensation be objectively determined relative to the market? Should you use target performance numbers such as 15% return on equity(ROE) along with 15% sales growth as important guidelines? Should compensation be based on the complexity of the position rather than title? Should there be an executive committee made up of siblings and/or cousins to be a policy making body, and additional compensation could be paid to the members of this committee? Should you have a team with a designated leader, all of whom receive equal pay except the designated leader, who would receive additional compensation?

 

Types of compensation cultures:

Entrepreneurial-Compensation structure is a way to achieve tax savings and have maximize control over the business.

Family First-Decisions by the business leader on how to best meet the family member’s needs.

Bureaucratic-Business owner creates such a rigid and complex process for setting compensation that any goals that might be achieved through managing pay are forgotten. What people are paid has nothing to do with the direction or goals of the organization or their actual performance. It wastes the opportunity to make pay a strategic tool for family and business achievement.

Custodial –Goal is to preserve shareholder value and tips the scales away from rewarding personal effort towards only rewarding ownership. It gives family member employees little incentive for working hard, other than knowing their rewards may be in the distant future, in something that they are helping to create value in now.

Strategic Management-compensation is used as tool to create a climate for achieving strategic goals. Pay is based on performance as measured by a set of objectives for each job that has been developed jointly by employee and their key manager for meeting strategic goals.

 

            Criteria For Determining a Job’s Market Value

 

Position-What are others in similar positions paid?

Industry

Size of company

Number of people supervised

Dollar value of assets overseen

Sales or revenue volume

Sales based on higher margins to the company

Cost of living, based on location

Profitability

Qualitative Criteria-Communications, Leadership, Integrative Abilities, Influence on Business’s Strategy, Interaction With All Parts of The Business, Is The Job All Internal, Or Does The Leader Represent The Business To The Outside World And To Whom In The Outside World-CEO’s etc., Command Of Business Issues

 

                               Incentive Plans

 

Create a culture that when the business does well, everybody does well, but you need to be careful not to tie compensation too closely to performance, as depending on what an executive or employee’s job function is, they may or may  not be able to significantly influence profits, and it cause undeserved windfalls or lead to the loss of critical people.

 

If an incentive plan is based on performance, you must define the levels of performance-outstanding, good, below average, etc.

 

A cap on incentives is appropriate to prevent windfalls from commodity rates or currency rates.

 

Discretionary bonuses can be included such as progress made to groom and develop a successor for a particular position.

 

Short Term vs. Long Term Performance-short term may be improving annual profit, revenue, cash flow or return on equity. Long term may include increasing shareholder value or book value over 3-5 years. Perhaps the weighting could be 2/3 short term and 1/3 long term.

 

Combination of Individual and Team performance-A realistic balance should be designed here-too much team incentive could de-motivate top performers; too much individual could cause damaging internal competition.

 

Incentive Examples: Company A: Depending on this years profits, if they are above normal-next years profits if they exceed this years will be shared with management-20% to top 5 managers and 10% to next layer of managers. Company B: Decided that pre-tax return on capital should be 15%, which is an acceptable return to shareholders. 1/3 of profits beyond that minimum return of capital would be placed in a pool to be distributed among executives, which half of that would go to executives proportionate to their salaries and the other half distributed by the CEO based on a discretionary decision. Company C: Seeks to reward sales growth and customer satisfaction-Executives get a bonus based on percentage of salary equal to the same percentage of sales growth that occurs for that year(or ties this to profits). Additional bonus may be paid for a certain percent of customer reduction in returns or allowances. Company D: Create a formula for a total dollar profit improvement over three years and pay out 1/3 of the earned bonus each year and retain the 2/3 for the future. The real key to any incentive and compensation plan is to tie it to the enhancement of shareholder value, as that tends to align performance measurements of management with wealth creation for shareholders.

 

Any compensation plan, including incentives should always be very clear on perks: What are they, who gets them, how are they controlled, who manages them what is the value associated with each perk, how are they to be used, and what does your policy on perks say about your company in relationship to the marketplace?

  

      Aligning Family Expectations and Compensation  Philosophy

 

How do you want your compensation to be determined in your business?

 

How does it compare to what people are paid elsewhere?

 

Next generation question-How can my parents afford to live as they do? Will I be able to live as well as my parents?

 

How much does the business have to grow to support all members of the next generation who may want to work here?

 

Examples of behavior that send good messages to the next generation: Live beneath your means; Learn the capacity of sacrifice; Avoid conspicuous use of perks; Limit use of credit cards; Don’t use the business as a conduit for tax deductible support for children; pay only what the job is worth when children enter the business and only increase pay as experience and performance warrants it; the business should not be the employer of last resort; Set standards for entering the business and stick to them; Consider training periods with expected growth and performance as family members enter the business; If a family members chooses to gain outside experience or if they are required to work outside the business before joining the family business, perhaps their pay could be subsidized by the family business  while they gain that outside experience; Share and communicate income sources with children-how much from salary and bonus from business, how much from inheritance, how much from savings, how much from dividends, or other sources of income- It’s important for children to understand this.

 

Discussing compensation matters is a natural way to help family members plan careers within the business. It helps family members set goals and objectives for themselves. It helps them understand what qualities and abilities are most highly rewarded in the business. It helps them understand what skills will equip them to aspire to the highest ranking positions in the company. Understanding the compensation structure in the family business helps the next generation to become a trusted part owner of the business. Will siblings and cousins be paid based on  the market value of their job or paid equally as members or a partnership? How will entrepreneurial contributions be rewarded? As family members marry, there should be clarity and communications on how pay is determined, as if it’s held in privacy, resentment and suspicion can develop.

 

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