Why are Compensation Issues in a Family Business Different?

by Robert Wilkening

Yes, pay issues in family-owned and operated businesses are different and in many ways more difficult to address than those found in other private (or investor-owned) companies. What creates this difference? In our experience there are several reasons that explain these differences. We have summarized five below.

As you read on, see if the same situations or explanations we describe exist in your business or within others you know.

  1. There is A Lack of Detachment.–As a family-employee (or other stakeholder [i.e.: a company employee, company shareholder, to-be shareholder, an in law or other interested party]) in a family-owned and operated enterprise; you can never get away from the “office”. Issues such as differences of opinion regarding pay and approach will follow you home and anywhere else family members gather. As we often say: Be ready to talk about it over Thanksgiving dinner.
  2. Pay decisions & Value are Seen Only Through Your “Filters.”—Compensation decisions within a family business are often considered and made by and amongst members of the same generation. These same family members have generally grown up together and have had many years to form impressions about the value or worth of other siblings (or cousins). With these same predetermined values and feelings in play, a sibling may now be asked to agree to pay a brother, sister or cousin substantially more or less than others—or themselves—based on the job each do. Why are they worth more than me?This is often a hard question to answer when your impressions and history (your filters) says otherwise.
  3. Family businesses are often the great levelers of family-member talent and ability.—Some family members may institutionally earn more within the family enterprise than they could ever earn in the outside marketplace—based upon skill, experience and ability. And, the reverse can also be true. For example, in some cases all family employees may be paid the same—in spite of the fact that one is the CEO and another is a Maintenance Supervisor. Hence when the subject turns to the “real” value of each job (and it always does), generally at least ½ of family employees will want to stop that discussion immediately—for obvious reasons.
  4. It is a democracy, isn’t it?—As family-owned and operated businesses mature and grow through succeeding generations, the number of family stakeholders (shareholders and other interested parties) can grow to a relatively large number. By the time the business reaches its 4th generation, it can have as many as 30 stakeholders—of which only a few typically work within the business. 

    Consequently, many of these stakeholders will have little or no ownership stake in the company. Yet, every family stakeholder has an opinion regarding pay for family-members, and many will not hesitate to state it. These opinions may either be anchored in fact or firmly rooted in opinion or personal circumstance. “What do you mean you are going to pay the CEO $200,000 in salary per year? I hear that the job is worth half of that! I strongly object.” (Really means: Wish I could make $200,000 per year.)
    In a family businesses—unlike in many others—there can be many chefs wandering about the kitchen on the matters of compensation. Some will be helpful and informed, others will not—but they will have an opinion that cannot be ignored. Just like in a democracy.
  5. Wait, whose money is that anyway?—Family business often have very complex and intersecting flows of pay, returns and cash distributions.  Some stakeholders (particularly those who are not employees) see all cash withdrawn from the business as compensation to be a reduction in possible reinvested capital and a possible corresponding reduction in firm value. 

    Hence stakeholder pay decisions can be viewed as decisions to award cash value to a family-employee before other stakeholders can liquidate their ownership (or would-be-ownership) interests in the company or collect other ownership distributions, like dividends.

    Some would argue that while some family members are focusing on the health and growth of the business, others are trying to preserve the current value of the enterprise (as if it were an estate). Such tension can be constructive particularly in trying to prevent de-capitalizing the enterprise through compensation. While many companies face similar questions, this debate can be vivid in a family-owned business—and must be carefully managed within a family-stakeholder “democratic culture.”

In all of the above we have neglected to adequately mention the pervasive influence of “Mom and Dad” upon pay decisions in a family business. It is often their values and direction (implicit or not) that establish the company’s pay strategy and influence all pay decisions for the next generation, or longer. And, their values & direction are seldom challenged while they are active within the enterprise. We have seen this situation result in a frustrated (and self-enforced) silence as pay differences and opinions amongst stakeholders “boil” just below the surface. It is not unusual to also encounter this “back story” when the subject of compensation arises over the dinner table.All or some of the above generally combine to make the management of compensation in family-owned and operated businesses different and potentially more difficult and challenging than in other firms. This challenge and difficulty can often lead to trouble within the company and family, unless effectively addressed. What should a company and family do?

Wilkening & Company has developed principles for effectively managing pay in family-owned and operated businesses based upon decades of experience addressing these challenges. We will outline those principles for you in next month’s E-Notes.

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) 823-5870