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Tackling family member compensation.

May 1, 1995 12:00 AM


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Most businesses in the printing industry are owned by one individual or family. Since stockholders also are managers, decisions about management compensation are made without regard to the effect on stockholders' value.

If employees become shareholders in the business, the scenario changes. Majority owner-family members should be aware of how their compensation impacts stock value, and develop a formalized family compensation plan.

The president of a family business has different motives from the president of a public company. In publicly traded firms, management's goal is to show profits on the bottom line of financial statements. Profits translate into dividends and appreciation in the value of the shares. Individuals buy company shares to earn a return.

In private, family-held businesses, the focus is different. Since management and owners are one and the same, they are more interested in minimizing taxes than showing a profit. High business income translates into high taxes. Dollars added to the firm's retained earnings account are taxed a second time when they are removed from the corporation or company shares are sold.

Owner-managers lower business earnings through compensation, perquisites and benefits. Controlling family companies allows them to determine their own salaries. If the firms are successful, year-end profits can be paid out as bonuses, with no concern about how compensation will affect stockholders.

However, few owners have total discretion over whether or not to retain profits. Companies must retain earnings to fund growth, purchase new plants and equipment, and meet requirements set by outside institutions such as banks or other lenders.

Once others are included in the ownership structure, family owners' compensation and benefits will impact the stock value, including shares owned by employees. It is common to use stock value based on the earnings or the increase in the owner's equity account. Compensation paid to family members will decrease financial statement earnings, reducing employees' share appreciation.

Does including employees in the company ownership require family-member owners to cut their pay and benefits? No, unless family owners remove all corporate earnings each year.

The employee-owner's primary concern is not the amount of owners' compensation, but the consistency of the approach. Employees want to know whether the firm's performance is the same as last year and how much the stock will appreciate.

Creating a formalized compensation arrangement for family-member owners is a common method of dealing with the compensation issue. The plan should delineate base salary, benefits and perquisites. The greatest variable usually is found in bonuses since many owners take large bonuses when earnings are good, and little or none in lean years.

Establishing a bonus for family members based on a formula usually is fair to all involved parties. The formula could be a percentage of pretax income, a percent or dollar amount after a minimum return on equity or a sliding scale percentage based on profit level. In any case, it is advisable to test any formula on historical data before proceeding.

In addition, the compensation formula should address differences between the roles of manager and stockholder. In family businesses, these roles become blurred. If other stockholders are involved, managers should be paid for their contribution to the corporation's success, not for the number of shares owned. Therefore, all stockholders will share in the appreciation equally after management has been fairly compensated.

If employee-owners are included in a privately held firm, the business must be run similar to a public company. A major goal of having employees own shares in the business is to motivate them to perform, increasing the company's value.

Workers are motivated if they believe the effort will translate into meaningful appreciation in their shares. Addressing the family member compensation issue removes one of the biggest obstacles to the success of employee ownership programs.