Many family-controlled companies face a multitude of complex business decisions as it marches forward to the next generation. Without any internal and structured plan, complexity and confusion can overwhelm the family and the business. In today’s article, our focus will be on family executive compensation, an extremely sensitive and perceptive matter. Call it a huge elephant in the room, but it is an area that can swing either way: help positively trigger the development of the leadership team and encourage the generational transition, or serve as a stumbling block to continued business growth. 

Former Deloitte UK Partner Peter Leach once remarked, “In the family system, the guiding norms are that family wealth should be distributed either according to need or according to principles that are transparently fair. In the case of siblings, for example, fairness is generally taken to mean that resources are allocated equally. But in the business, remuneration should be based on the individual’s contribution.”   

What is the Right Compensation System?

In my family advisory work, this compensation problem is exacerbated by the founders’ wrong notion of fairness and equality. Instinctively, the owner/parents would opt to follow the family system where the acceptable norms are that family wealth should be distributed either according to need or according to fair principles. By pursuing a family system (family first instead of business first) of compensating relatives that is flawed, the business leader has started a culture of entitlement. It is a grievous mistake and can create all sorts of tension and stresses that will play out in this volatile environment. This founder mindset of family first must stop, and it’s essential to break this paradigm, both to manage expectations among the children and to attract non-family talent. 

How can founders and business leaders address this looming risk management problem? What can the family business enact or initiate to diffuse possible jealousies among siblings or cousins? How can a parent/owner openly discuss a fair, rational (not equal) compensation system to his children without alienating others? How can the family business incentivize performing family members and sanction the underperforming ones? How should the patriarch treat family members that are not working in the business? What does profit sharing mean? Is it similar to dividend sharing? How can the family institutionalize and structure a pay system for the children that won’t be perceived as nepotism or favoritism? Should it be the founder leading this compensation planning initiative? Should it include everyone in the family? Should the human resource head be part of this plan? Should it be confidential, and is HR qualified in the first place? How does a market-based compensation system work? Is there still time to change the current pay structure when the children are already in their 30’s or 40’s and married? How will the next generation adult members feel about the change? What about the children with the most offspring? Should their compensation be higher since they have more household bills to pay?    

Stop procrastinating; start the process now!

When confronted with questions like these, where and how do you find the answers? Can the answers be found amongst local business clubs or chambers, or should they seek help from fellow business owners? How can it be implemented? Parents/owners have long felt a growing resentment among the children, yet they always struggle to initiate the right plan. 

To ensure that salaries are distributed fairly among family and non-family employees, business leaders should match them with industry guidelines for each job description. When additional compensation is needed to reward family members for their contributions to the company, other benefits like variable pay can kick in. For some families that are driven by corporate best practices, stock option plans and equity distributions are considered.