Take the Right Steps to Best Compensation Policy

How to compensate has been a dilemma since the hunting and gathering societies. From communism to capitalism mankind has questioned the value of work, education, time and brawn. Even within capitalism, we range from “performance bonus” to “union scale” -“ a wide variety of employment reward systems to say the least.

Family businesses are notorious for confusing the business and family systems. It is no different when it comes to compensation. Family members are usually cast outside of the compensation policy used to reward the rest of the employees. Bad practices evolve from bonuses for house down payments or having babies to underpayment with the premise that “one day this will all be yours-¦” Probably the practice that heads the top ten list of bad practices is paying all the children equally regardless of their relative value to the business, educational background, experience or expertise -“ that is unless you pay someone for being non-productive and even staying at home.

While there is no “right” compensation policy, there is a process that will solve inequities and the annual debates. Make no mistake, you do have a policy even if it isn’t in writing. If you are not sure what it is, just ask around. One way or another, if you don’t have a written policy, then your employees will respond somehow with “management discretion,” or something similar. While that is a policy, you may want to draft something more specific that will provide for both the family and non-family in a fair manner.

Start with a compensation philosophy. How does your industry pay? How does your company fit into the industry standard? Is your compensation policy individually performance based, or is it more of a team effort reward system? Do you reward goal achievement? Do you promote from within to increase compensation potential? Is your fringe benefit package optimal or minimal? How are profits shared -“ if at all?

Draft a few paragraphs that state your company’s compensation philosophy. It will make the rest of the task that much easier. Keep in mind that you want to be competitive in your market to attract and retain good employees.

Fair Market Value
There is a fair market value for a job and the range of compensation for that job is a findable thing. Any search engine will return millions of sites on compensation. Many of those sites offer data based on job description, industry, company size, location, etc. The difficult task is matching the actual job to the job description on the site you chose to use. You may have to combine and average to make things work. If you can find a site that is specific to your industry (like construction, or retail), you stand a better chance of finding parallel job descriptions.

Naturally, if you don’t have existing job descriptions, you will have to start there. You might ask everyone to create their own first, and have their superiors work with them to fine tune the results. Again, there is an abundance of sites that can help with this task. Once “final drafts” have been obtained, your executive team should review the results for omissions and overlaps. This task will also offer a great opportunity to streamline your organization. Organizational mapping would be very useful.

Next, go the site you have decided to use and research their job descriptions. If you don’t find solid matches then you will need to improvise a bit. Next, you should be able to apply your philosophy to the data you have obtained and come up with a range of compensation. The data will break down the compensation into “regular salary,” bonuses, and fringe benefits. It will give you a selection based on percentages. This is where your philosophy will help you with establishing your range.

Let’s say you decide that you are going to pay on the low end of regular salary, but offer larger incentive bonuses based on profitability. In addition, you want to offer a fringe benefit package in keeping with your industry and location. You might develop a range of pay within the 25-50 percentiles for that job description; define your bonus plan and fringe benefit package. This allows you to reward the employee based on the job and their individual skill sets. If you have a top performer, they should be at the top of the range. If you have a new hire with little experience, they would be at the bottom. It also allows you to adjust for education, attitude, seniority, as well as other skills you find desirable.

You can then decide what to do from year to year. I suggest an annual cost of living increase based on a relevant Consumer Price Index with a re-ratchet every three years. This allows you some flexibility to offer raises for those who deserve to move up within the pay range and to adjust the pay range every three years. It also prevents over paying for a job. Once someone maxes out at the pay range, they can only look to CPI or re-ratchet increases. To make more money they need to get a promotion to a new job description.

This policy would hold for family and non-family alike. It is also best administered by a small committee (three is a good number) to add objectivity.

Bonuses are a key element of compensation. Employees come to expect a bonus after the first one they receive. Any compensation policy should address how bonuses will be determined and paid. Usually, bonuses are based on individual performance against some goal -“ like sales, or profit. Keep in mind that if you offer a formula, then the data used to establish the numbers will be questioned. If the bonus is based on profitability, your accounting is likely to be challenged. If you do not intend to share financial information, it would be better to find a way to offer bonus incentives that won’t be based on the way you do your accounting or take your income. Units of widgets, sales volume, percentage increases over a previous time frame are ways of eliminating the need to share financial information.

If other family members are part of the bonus plan, and you intend to treat their bonuses differently than non-family, then you need to make it clear exactly what constitutes their bonus. You might want to write two checks -“ one for the regular plan and one for the family plan. Often the family plan is really a dividend or distribution of profit because someone is family and no other reason! Often these distributions are given to family members who are not current owners and that amounts to the real owners sharing their return on their investment. The key is that whoever gets a check needs to know what it is for and feel deserving. Otherwise, the concept behind a bonus as an incentive is a very mixed message.

Be mindful of your bonus plan offering a formula that pays out in lean years, or that pays at a time when there might not be sufficient cash. Remember to, that bonuses reward past performance. They only offer incentive if they are expected in the future. Most employees consider them a part of regular compensation and feel cheated if the bonus either decreases or is omitted.

Any compensation policy requires a corresponding evaluation process. Again, it is best if the evaluation is done by a small committee to add objectivity. It’s also best if the evaluation is delivered to the employee at some time other than when compensation is being adjusted. Otherwise, it is likely that the only message will be the compensation adjustment and not the other facets of the evaluation.

Use Caution
If you decide to revamp your entire compensation policy, you must crunch the numbers. Any revamping will likely yield some employees getting increases while others suffer decreases. While this might address fair market value, it will lead to some turmoil. You will need to crunch your overall payroll changes and compare it to your current numbers or you could make a big mistake!

Getting buy in from your key employees will go a long way to preventing the turmoil. Working with a small committee to get the job descriptions and determine fair market value will work wonders for employee acceptance.

It is strongly recommended that you retain a competent professional to guide you through this process. In the end, you will find this compensation policy format makes great sense for both your business and your family.

Rick Segal is a family business consultant and chairs the Family Business Council -“ a membership organization for family firms in Southeastern Michigan. He has served as an advisor and director on several family business boards. He can be reached at [email protected] or visit www.segalconsulting.biz.