Should You Pay Bonuses or Dividends in your Family Business?

Words: Greg Lewis

Keeping the Family Happy in Ownership and Relationships

Words: Greg Lewis
Photo: kiattisakch

Family business owners often get tangled up with being “fair,” especially when they make their children stockholders in the business. We get the question often: “Should we pay bonuses or dividends?”

Unless you are good with the numbers and tax law you should turn to a CPA or tax attorney for help. That is a good place to start because bookkeeping and staying current with the taxman is no laughing matter. The last thing you want is an audit that eats into profits…or worse.

But CPAs and tax attorneys are more useful for keeping the IRS happy. They may not always think through the implications of how your children may feel when you try to be “fair” and it doesn’t work out so well. 

This is a situation that calls for insight from other family business owners, who have experience in keeping the family working together and the business performing. 

The owner of one family business, we’ll call him John, had two daughters, neither of whom ever worked or contributed to the business. Both of the daughters did not want to own the business after their Dad retired so John sold it.

When John sold the business he gave each daughter an equal amount from the proceeds. That’s awesome! An ideal situation. No problems here.

In another scenario, Diane’s four sons all worked in the business. One became the chief of operations, two served at length as software engineering contractors, and the fourth became an attorney and served as their legal department.

Those are the easy scenarios where you can split the proceeds evenly among everyone involved. Nobody’s short-changed, and nobody’s left feeling like they did all the work and there was no reward.

Why It’s Not That Simple

But let’s be honest, most situations aren’t going to work out that easily. Let’s make this a little more interesting, and more like real life: two brothers own a business together.

So far, so good…a 50/50 split. But eventually, each brother gets married, and one brother has four children, while the other has only one child.

The brother with four children brings his youngest daughter into the business, where she helps the business grow and builds equity in the company. Her three siblings, however, have almost nothing to do with the company…but their father made them equal owners to their sister who works in the family business because he wanted to be “fair.”

Meanwhile, the other brother also wanted to bless his only son with ownership, but that son also pursued different interests. He didn’t join the business as an employee, but he does have ownership in it (the same amount as his cousins).

How would you pay your children equally and fairly when not all of them work in the business? You can’t pay bonuses to someone who doesn’t work in the business, so that means the child who works in the business could receive a BIG blessing…but then the others wouldn’t get anything.

On the other hand, you could pay dividends equal to the children…but that could also invite problems. The daughter who now works in the business is bound to learn, at some point, that her three siblings were paid the same amount as hers for doing nothing…while her cousin who has no siblings and doesn’t work in the business gets paid as much as four times what she does! Now that’s a problem!!!

Pros and Cons of Dividends and Bonuses

First things first. If you are NOT currently paying your company first, before the taxman, payroll, suppliers, or debt – we don’t recommend dividends or bonuses.

The first thing you should do is reconstruct your family business’ financial plan to pay itself first – even if one percent is all you can afford to put in the profit account. You can learn more about this in the book we recommend for our mastermind members – Profit First by Mike Michalowicz.

The question of dividends and bonuses also comes down to how you’re organized. It usually depends on your size and structure as a company. It’s far more common for a “C” corporation to pay dividends, but there are instances where an “S” corporation can pay them too.

If your business were not family-owned, you would probably look at performance the way regular corporations do. When there are growth and improvement, employees receive bonuses, while shareholders get dividends.

Some family businesses avoid bonuses and dividends altogether, preferring to allow equity to accumulate within the company. There are so many variables to how this can play out! It’s simple enough if you can remain a very small shop with a large income. But growth usually implies adding staff to manage more details. If there are no bonuses or dividends you basically have a JOB. Who wants to own something if there is no return (dividend) for owning it?

We’ve found there are two questions you should always ask when deciding this. The first is fairly simple: “What do we need to live on?”

Now, if the answer to that question comes at the cost of making investments in the people who make your company work, you may need to rethink how much you want that lavish lifestyle. We love to see families enriched by a successful business. But if greed motivates them, we’d rather help them wrestle through it.

In other words, if you can provide a comfortable lifestyle for your family on $150,000, you’d be wiser to start benefiting everyone else. Think of all the people who make your business work – customers, employees, suppliers, referral partners – and especially your family members who work in it! Small, valuable, personalized gifts make for great relationships.

The follow–up question is, “From what’s leftover, where is it better spent?”

One way or the other, that money’s going to go somewhere, and Uncle Sam will be happy to take it if you can’t think of anyone else to give it to. If you can’t hang onto it anyway, why wouldn’t it be better to put it in the hands of family members and key employees who are helping you to succeed?

Conclusion

Should you pay bonuses or dividends in your family business? After taking care of your tax responsibilities with the IRS the answer to this question is how can you best keep your family happy in ownership of your family business and your relationships with each other by distributing profits? From transition planning, leadership succession, strategic planning, organizational management, and executive coaching, our team is prepared to help your family THRIVE, your business to Perform, and working together you can create a lasting legacy. To ask questions about how to successfully transition your business, call us today! If you want to talk….We’ll listen!!

Greg Lewis is Co-Founder/Family Business Advisor with The Tennessee Center for Family Business (www.tncfb.com) located in Nashville, Tennessee, and host of Family Business Today podcast. His wife, Jennifer, is President and a family counselor.  He can be reached at glewis@tncfb.com or 615-513-9028.

Comparison of Laying Brick Versus Block

Brick and CMU (Concrete Masonry Unit) are two commonly used materials in masonry. As a mason, it is important to understand the similarities, differences, pros, and cons of both materials, as well as the variations in layout and measurement techniques, mo

Westlake Royal Building Products™ to Showcase Be Boundless™ Campaign, Top Industry Trends and New Product Innovations at Pacific Coast Builders Conference (PCBC)

HOUSTON (June 18, 2024) — Westlake Royal Building Products™ (Westlake Royal), a Westlake company (NYSE:WLK), will showcase its Be Boundless™ campaign, top industry trends and new product innovations at the Pacific Coast Builders Conference (PCBC) in Anahe

Bringing Bricks Back To Life with BrickRecyc

BrickRecyc, a machine that removes old mortar from bricks, was invented by three entrepreneurs from Quebec in 2021. Tommy Bouillon, David Dufour, and Hugo Cartier were the innovation's source. The invention emerged out of necessity. Tommy Bouillon, head o

Are Your Employees Safe While Working In Hot Weather?

As the temperatures rise outside during summer months, so do the risks that employees working in hot conditions may be harmed by the dangerous effects it can have. Exposure to high temperatures can be deadly. It’s your responsibility as a business owner