This week, Niall Glynn, a partner with Deloitte in Ireland, discusses the compensation of family employees.

For family employees in family businesses, compensation can often be one of the primary causes of conflict. It is extremely important to have clear parameters for reward and avoid basing compensation decisions on emotive criteria.

Children often base their financial expectations on a perception of their parents' income. In a family business context, the typical assumption is that this derives from employment in the business. It is therefore important to educate children early that family wealth may derive from a variety of sources (including investment income, inherited wealth, savings, and dividends from family trading companies).

This may help temper expectations about the monetary reward involved in being a family employee.

What are the common pitfalls?

Compensation principles often differ in family businesses when compared to public companies.

Common pitfalls include:

  • Paying all family members the same (top performing family members may be underpaid while underperforming family members are overpaid)
  • Paying family employees under market value (which can lead to resentment) or significantly over market value (which can create unrealistic expectations)
  • Providing family members with roles (and paying salaries) so that they have "something to do"
  • Paying family employees based on their needs (e.g. lifestyle, medical) rather than for the requirements of the role
  • Trading on family relationships by not discussing reward appropriately/fairly
  • Using reward to control children who are employees (e.g. paying them too little on the promise that ownership will pass to them in the future, or paying too much to entice them into the business)
  • Avoiding uncomfortable discussions entirely (such as why one child should be compensated more than another)

All of the above have the potential to create conflict, and can lead to unrealistic expectations, lack of ambition, demotivation, frustration for non-family employees, and conflicted emotions about loyalty vs. reward.

Ultimately, these pitfalls can lead to general confusion about whether compensation decisions are based on an individual's status as a family member or their role and performance – something to be avoided in businesses where family and non-family employees work together.

What strategies can help prevent conflict over compensation?

When I advise family businesses on compensation, some typical practices that can help to minimise the potential for disharmony include:

  • Managing expectations early
  • Including information on remuneration criteria (and the factors that determine reward) in family business policies
  • Creating roles and employing people solely on business need and individual suitability
  • Having objective performance appraisals for all staff, whether family or non-family members
  • Basing reward and promotion on appraisals
  • Benchmarking reward against market rates
  • Involving non-family managers in decisions on the promotion of family employees
  • Establishing a remuneration committee composed of (some) non-executive directors

In my experience, there is rarely an appropriate substitute for paying market rates based on the requirements of the role, with all other discretionary reward, bonuses and promotion decisions being based on merit. Informing family members of the above (as part of a wider transparent communication policy) can help to manage family expectations, and reduce the potential for future disharmony.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.