6/27/2014
Family Paychecks
Bill McCurry
If the government encourages you to do something it’s usually a bad business decision—especially when it concerns payments to family members. Many CPAs suggest business owners boost the pay of their employee-children. This reduces the corporation’s taxable income, shifting it to the potentially lower tax rate generation. It can also give the kids money that parents would otherwise gift them in after-tax dollars.
Parents want their kids to “be better off than we were,” but they may have forgotten that rough times prepared them for later success. Countless studies prove when humans intervene to ease the hatching of any egg-born creature, it actually harms them. These animals’ lungs and muscles are strengthened by the struggle to break out, so nature keeps them shelled until they’ve built up the stamina to survive.
While our human offspring didn’t hatch from a shell, they also need the “tough love” of scarce resources and significant challenges that build inner strength and character. Unlimited access to the business “cookie jar” teaches all the wrong lessons about corporate governance and family wealth accumulation.
I often attend “family councils” when their business is collapsing. A significant number of family members won’t address the situation unless they’re guaranteed their income won’t suffer. Many long-established family companies don’t exist today because the next generation viewed it not as a business, but as a bottomless piggy bank with ATM accessibility.
Shifting wealth through the business teaches all the wrong lessons. Family learns to just get a company check when you need cash, whether or not you’ve earned it. Today’s relatively new buzz word for this is “entitlement.” A much older word—profit—comes from the 13th century. For small business, profit is defined as: “Compensation accruing to entrepreneurs for the assumption of risk in business enterprise as distinguished from wages or rent.”
Here’s where tough love really gets tough, especially with siblings/cousins/in-laws. In one case, three brothers all made the same salary, which was “fair” in their parents’ eyes. The oldest had a high school diploma, the middle son had an MBA and the youngest dropped out of college his sophomore year. The oldest son was an auto mechanic, a shop manager who supervised eight other mechanics while handling customers. He took a pay cut to work for Dad. The middle son was ex-military and also took a cut in pay and benefits to rejoin the family company. The youngest had zero job experience outside the family business. (See last month’s column on Roots and Wings.)
When grandkids came along and “the kids needed the money,” all three paychecks were dramatically increased an equal amount without regard to experience, hours worked or contribution.
The family rejected my suggestions and today the business is gone. They said the suggested pay cuts were too tough. They had neither the money nor the courage to pay their MBA son more than the others. Ironically, the brothers went into different industries, started their own entrepreneurial ventures and are successful to differing degrees, happier than ever before.
Had the family taken the Roots and Wings approach, the marketplace would have told them each brother’s value. They could have looked at job description, not kinship, asking, “What would that job pay if you weren’t family?”
Depending on many variables, the best approach is to set the routine paycheck based on the lower end of market wages, augmented by an annual bonus. This bonus is based on how the family member performed and on how well the company did overall. With this model properly implemented, the family quickly learns they and the business must be productive. If targets aren’t met there’s no money for bonuses. Monthly incomes stay the same. Some parents criticize this as harsh. These same parents might help the chick get out of the egg, denying it the muscle-building exercises that will support it throughout life.
GP
Bill would love to hear from you with questions, comments or ideas for future columns. Please contact him at wmccurry@mccurryassoc.com or (609) 688-1169.