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Succession Fireside Chat: What compensation structures work best for my family business?

Succession Fireside Chat: What compensation structures work best for my family business?

Synopsis
4 Minute Read

How can you ensure every member of your family is compensated fairly during the succession process? MNP’s Lynne Fisher, Steve Ivacko, and Eben Louw discuss some of the challenges around compensation and best practices for success, including:

  • Paying market rates
  • Separating additional benefits
  • Managing expectations around sweat equity
  • Reviewing compensation
  • Recording agreements

 These steps can help you overcome obstacles and ensure every member of your family receives fair compensation before and after the succession process.

Compensation can be a difficult topic for family members to discuss — but succession can bring these concerns to the forefront. How do you manage expectations and ensure each of your family members are compensated fairly for their contributions to the business?

In the second episode of our Succession Fireside Chat series, MNP’s Lynne Fisher, Steve Ivacko, and Eben Louw advocate for implementing fair and equitable pay structures for family members. They also provide guidance on how to define your compensation plan and discuss additional considerations during the succession process.

Watch the full video above or read the article below to discover how to navigate the conversations around compensation that you may encounter on your succession journey.

What is a family compensation structure?

A family compensation structure is how your family members are compensated for their contributions to your business. It is essential to establish a fair pay structure to maintain harmony between family members and ensure everyone is motivated to contribute to the success of the business.

What are the four types of compensation?

The compensation structure you choose will vary based on your family’s business structure, industry, and goals. These are the four most common types of pay structure in a family business:

  • Salary-based compensation — Family members receive a fixed salary based on their roles and responsibilities in the business.
  • Performance-based compensation — Family members receive bonuses or incentives based on reaching set performance metrics.
  • Dividend-based compensation — Family members receive a share of your business’ profits as dividends in proportion to the ownership stake they hold in the business.
  • Equity-based compensation — Family members are compensated with ownership stakes in the business such as shares or stock options.

What is the most common type of compensation?

Most family businesses choose a salary-based compensation structure for family members. This provides a predictable and stable income based on market rates. Additionally, it helps to ensure transparency and separate their role in your family from their role in the business. Furthermore, having family members paid at market rates reduces the likelihood that employees see family members as having an unfair advantage.

How do I create a fair compensation plan?

Compensation may not currently be an issue in your family business. However, succession planning often brings concerns about compensation to the forefront. If those concerns are left unaddressed, it can become an all-encompassing issue with the potential to affect family relationships, succession planning, and even the value of the business.

An equitable pay structure can help ensure every member of your family is treated fairly and prevent compensation from becoming an issue during the succession process. These best practices can help you implement a fair and equitable compensation structure:

Pay market rates

Base your pay structure for family members on market rates — for example, if your family member is a welder in your business, the market pay range may be $15 to $35 per hour. A family member with years of experience and who consistently performs well should be paid at the top of this scale. However, the pay rate for family members with little experience or who are not meeting the expectations for their position should be based near the lower end of the scale.

It is essential to pay your family members in the same way you would compensate any other employee within your business. Seeing that family members receive the same compensation and incentives for the work they perform helps increase employee retention and loyalty — increasing the value of your company. If you are considering selling your family business to a third party, it also helps ensure the value of your business is accurate and increases buyer confidence in your financial information.

Paying market rates can also help motivate family members to perform at their best and encourages continuous improvement — supporting the long-term sustainability of your business. Additionally, it can help reduce tension by allowing your family members to see that they are being compensated fairly for their skills, performance, and experience.

Separate additional benefits

Separate additional benefits or perks — such as distributions, a vehicle, or health benefits — from the compensation that family members receive from their work in the business. Defining these additional benefits and distributing them based on clear guidelines can help prevent tension or resentment between family members.

Additionally, separating additional benefits from compensation can help support the financial sustainability of your business. It enables you to track how those benefits impact the financial health of your business and make informed decisions. It also supports succession planning through ensuring the financial sustainability of your business and encouraging the development of your family members’ skills. This supports a smooth transition of responsibilities in the future.

How to overcome obstacles during succession

Additional challenges around compensation may surface during the succession process. These three best practices can help you overcome obstacles and ensure a smooth transition process for your family business:

Manage expectations around sweat equity

Family members may expect their contributions to gain them future ownership or increase their shares in your business. It is essential to define how your family members will be compensated for sweat equity in the business to manage their expectations before the succession process begins. This will help avoid confusion, prevent resentment, and support a smooth transition of responsibilities.

It is equally important to remember that all your employees work hard to bring value to your company and should receive fair compensation. There may be employees in your business who contribute greatly to its overall value — and would bring even more value as owners. Considering the sweat equity of employees as well as family members can also increase employee loyalty and retention if ownership is a future possibility.  

Review compensation

It is important to ensure that every member of your family feels they are being compensated fairly for the time and effort they spend in your business. Asking family members to review each other’s compensation can provide transparency and clarity around how each family member is paid for their work. It can also reduce tension and prevent family members from feeling that some are being treated more favourably than others.

During the succession process, some family members may feel they have been underpaid and advocate for a larger share of the business. Asking family members to review and sign off on each other’s compensation can help provide a clear record of how each family member was compensated for their efforts over the years. This allows you to make fair decisions throughout the process.

Record agreements

Your family may have held many conversations around compensation — and a written record of agreements can help provide clarity during the succession process. This provides transparency around compensation arrangements and reduces potential disagreements between family members. If one of your key decision-makers is unexpectedly absent, it also ensures you can still answer questions around how each family member is compensated.

A written compensation agreement is a valuable tool to support the succession process. It can help facilitate a smooth transition by clearly defining compensation arrangements. Additionally, a written agreement can help new ownership gain a clear understanding of the financial expectations and responsibilities within the business.

Take our ExitSMART™ Succession Assessment

You’ve worked hard to create a successful business. Use our free assessment tool to discover if your succession planning is on the right track to get the most out of what you’ve built.

Take the next steps

Compensation can be a volatile subject with the potential to significantly impact your family and business relationships. Implementing a compensation structure that pays market rates and separates additional benefits can help reduce tension. Additionally, reviewing compensation arrangements regularly and recording agreements can also support a smooth succession process.

If you need support on your succession journey, contact a member of MNP’s Succession Services team. We can help you develop a succession strategy to increase the value of your business, minimize risks, and capitalize on what you’ve created.

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