The Dangers of Overpaying Family Members

By Prof. Enrique Soriano

 

Dr. Steve Maraboli once said, “a sense of entitlement is a cancerous thought process that is void of gratitude and can be deadly to our relationships”  Founders and business owners must never toy around with a family member’s remuneration package. It is a very sensitive topic as it involves money. Paying them with less than what they are capable of doing is not just downright dangerous but can compromise relationships among siblings and relatives. On the other hand, paying excessive compensation to those who are not deserving can demoralize non-family employee morale inevitably leading to a higher attrition rate and poor performance. Unless business owners confront pain points regarding compensation, this problem will continue to sow divisions within the enterprise.

I am sharing a portion of an email sent to me a few months ago by Larry, (a 67-year-old founder of a successful family enterprise): “My wife and I are extremely grateful that you never gave up on us. The turning point was when you were able to clearly articulate the dangers of overcompensating my children. I recall what you said that there is never a perfect time to discuss salary and compensation structures with the family. All along, I thought that all of my children were on the same page. I equated my generosity with a strong desire that they will all join me without looking at certain competitive pay structures.”

Larry’s wrong notion of compensating family members is common among founders and business leaders. They would normally entice their offspring by way of a financial carrot, where pay is used to lure family members into signing up for the family firm. Was the pay tied to issues like competition, fairness, ignorance in crafting one, or past guilt for being an absentee parent on the part of the founder? “The dangers to overpaying family members can lead to an exaggerated sense of self-worth and will encourage them to lose touch with the economic realities of life,” Family business consultant David Harland remarked. “When high salaries don’t come with high levels of responsibilities and performance expectations, children and young relatives may lose confidence in their abilities and feel that they’re still dependent on the family for support.”

Larry added, “it was a good idea where you suggested that we gather my children so you can initiate honest, straightforward conversation related to best practices on compensation. I was also relieved when you pointed out that pay for performance metrics is actually based on industry standards, that having benchmarks are an excellent way to establish roles, expectations, and salary levels…” There are many founders of family-owned and operated businesses that are notorious for paying excessive amounts of compensation to family members. These compensations usually exceed market value. In some cases, unconscionably high! And the reasons why family-owned businesses pay a relatively high level of compensation varies from providing support to the child or grandchild, to placate other family members, to prevail upon some family members to continue working in the business and provide “gifts” to them as part of the owner’s estate planning.

Whether the compensation paid to a family member is fair and reasonable depends on facts and circumstances. According to Louis Vlahos of Farrell Fritz, P.C., “in making this factual determination, there are various factors in assessing the reasonableness of compensation. These include the following:

• Family employee qualifications;
• The nature, extent, and scope of the family employee’s work;
• The size and complexity of the business;
• Prevailing general economic conditions;
• The employee’s compensation as a percentage of gross and net income;
• The family member’s compensation compared with that paid to non-family executives
• Prevailing rates of compensation for comparable positions in similar industries

Whatever the motivation for the salary, it is critical for business leaders according to Harland to “develop a fair remuneration scheme for all employees – family and non-family – to promote an environment of motivation and mutual respect.”