Tie Compensation in Family Businesses to Market Value

Family businesses have many strengths, and there are definitely benefits to family members working in and for their family business. However, the relationships family members have with each other and non-family coworkers make this business type more complex both emotionally and financially. Combine this with the always sticky issue of compensation, and there will be complications. Letting the market value of employees determine company compensation directly benefits the company and minimizes problems within the family and between family and non-family workers.

Why are Compensation Issues Complicated?

The short answer is: they’re complicated because money is something everyone has an opinion about. It’s also a yardstick by which workers – and family members – measure themselves. Furthermore, all family members in a family business feel entitled to opine on compensation issues regardless of whether they are shareholders or actively involved with the running of the business.

Unfortunately, as a family business grows older and more established, it gets harder for all the family members among the different generations to agree about compensation. When a family business has been operating for four or more generations, a multitude of people will weigh in on what people should be paid as if the company were a democracy. The fact that the business is not a democracy and isn’t run as a democracy doesn’t prevent this from happening. All family members believe that membership in the family gives people the right to opine and complain. Some family members will have advice or input that is helpful and informed, but others will not. They will expect to be heard, however, just as if the business were a democracy.

Compensation Requires Separating the Family from the Business

The solution to this problem is for the family to determine compensation based on the market value that family members bring to the company. There are many benefits to letting the market decide who should be paid what.

The first benefit is that paying family members according to their market value – what they would be paid for doing the same job at another non-family company – smoothly bypasses arguments about what is fair. An infinite number of ways to calculate what is fair exist, and every family member will have their own way of calculating it and will argue for that variation to prevail. Allowing this sort of arguing over value is neither good for the family or the business, so letting an objective measure like market value prevail is better for everyone.

The second benefit is increased performance from all family members. When all of them know that they will be compensated based on their work and skills, this creates an incentive for them to work harder and upgrade their skill sets. This will obviously benefit the company as well. It also results in individuals gaining confidence as they realize they are not dependent on their family connections or some sort of charity. They have agency and worth outside of the family.

Conversely, when all family members are paid the same as a way of equalizing family members and not showing favoritism, this acts as a disincentive since individuals know they’ll be paid the same no matter what they do or produce. If family members are paid “the family rate” or overpaid because of their membership in the family, they will never leave. This is harmful to the business because it wastes its capital paying for work that is of lesser value and a leadership position is occupied by a lesser talent.

Tying compensation to market value benefits both family members and non-family staff. It’s good for productivity and morale to pay all workers what they are worth. It also goes a long way towards diffusing any tension between the two groups about pay. Non-family workers are more likely to show loyalty to a business that they feel treats them fairly and doesn’t relegate them to a second-tier pay hierarchy they can never escape.

Finally, transitions between generations will be smoother when compensation is tied to market value. During periods of transitions tensions and actual in-fighting is more likely as leadership becomes less clear. When done right, a market value compensation system includes careful, routine, scheduled evaluations. The value of having a system of compensation in place that functions no matter who is in important leadership roles cannot be overstated.

Private family businesses too often ignore market realities when it comes to setting compensation and paying their family members for their work. They often pay family members based on emotions or loyalty rather than what they are worth. Pegging compensation to market value incentivizes hard work and education and minimizes discontent and family infighting. It’s a win-win for all involved in the business, family and non-family workers.

 

vince

Vincent Mastrovito

vincent@prometispartners.com
(616) 622-3070
250 Monroe Ave. NW, Suite 400 
Grand Rapids, MI, 49503

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