by Marcia Zarley Taylor, DTN Executive Editor
Taylor, DTN: Lance, in your recent column about compensation, you encourage people to set wages closer to the market than at unreasonably high levels. But what about families that pay themselves too little? I know some families of good Norwegian stock who pay their key owner-managers less than $30,000 per year in cash and recycle the rest of their profits as equity in the family business. That can cause friction when daughters-in-law have to ask for extra money for vacations or other “extras.”
Woodbury: Marcia, I’ve run into the situation several times. It might be the parents who only take out what they need to live on, or the brothers who agree to pay themselves only $20,000 each per year, when “the market” would pay them twice that amount or more. Fringe benefits probably bring the total value of compensation up a bit, but there are times when it feels people are taking the least they can out of the business, not because the business necessarily needs the cash, but because there is no need to take out more in personal compensation.
Taylor, DTN: What’s wrong with paying people less and leaving the money in the business?
Woodbury: If they intend to bring family members back into the business who have been working elsewhere, it sets up a potentially awkward situation in that the returning family member either has to take a significant cut in pay to be at a level below those who may have more experience or responsibilities, or others may need to have their compensation significantly increased, which may be too much for the business to handle all at once, or difficult to manage in years that are leaner and the business needs more working capital. My point is that out-whack-compensation, either too high or too low, makes the return of family members – already a tricky issue – that much more difficult to figure out.
The other issue is that leaving compensation in the business, and thus building equity in an operating company, makes it that much harder for the next generation to accumulate meaningful equity when they are ready to become owners. If the operating company becomes worth several million dollars, a younger family member receiving low compensation has limited ways to acquire meaningful ownership percentages, other than through gifts, which then complicate estate planning strategies.
Taylor, DTN: How do you suggest families have discussions about compensation?
Woodbury: The first thing people should do is identify or acknowledge, as a group, the current philosophy or approach guiding the compensation strategy. Then they should assess whether that strategy is viable for the long-term in light of their goals and vision for the business. If it is, and if they think it will work, then stay with it. Every family has a unique culture and approach, and there is no one-size-fits-all solution.
But if the compensation strategy will interfere with the long-term goals of the company – for example, attracting the best talent – then begin developing a plan to change the strategy over a number years. With the likely tighter margins for several years, drastic changes in compensation (to the upside) may not be feasible, but a multi-year plan may be workable. I also encourage people to include their accountant in the discussion and planning, as they can bring a more independent viewpoint to the conversation.
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Posted by Jami Howell