Jeffrey Wolfson is a family business attorney at Goulston & Storrs and is chairman emeritus of the Northeastern University Center for Family Business. email@example.com
It makes sense to formalise employment contracts, both for employees and employer in family companies. Employment agreements encourage healthy communication, prevent resentments from building up and avoid disputes arising later on, advises Jeffrey Wolfson
Ask most owners of family businesses if the company has employment agreements with its key family employees and they'll look at your quizzically and reply: "But we're family", or object: "It's contrary to our culture. Employment agreements are for companies that are publicly-owned or at least more bureaucratic than ours."
Such views, while common, are short-sighted. Family businesses need employment contracts with key employees, both family and non-family, just like other businesses do. A contract is the most efficient way to settle expectations over issues like compensation, titles, job responsibilities and lines of authority. A well-drafted agreement can also help protect the company, the golden goose that provides for the entire family, by requiring employees to sign appropriate noncompete and confidentiality covenants.
Still sceptical? Then ask the four sisters who held shares in a family manufacturing company but whose father and brother never allowed them to have an active role in management. They watched helplessly while their highly-paid CEO brother took 10 weeks of paid holidays each year and otherwise thumbed his nose at accountability. The board of directors were reluctant to intervene in what the outside directors saw as a family dispute and, unfortunately, no clear limitations on the brother's authority had been formalised.
A written contract would also have been helpful in the case of two brothers whose feud in the family company often spilled over into the car park. One brother, the company's president, unilaterally gave his son who worked for the business a pay rise. The increase angered the other brother who felt it was unauthorised and, accordingly, in his capacity as treasurer, refused to sign his nephew's paycheques. His nephew subsequently filed a complaint against both the company and his uncle with the Department of Labor. Both of these anecdotes are based on true stories and illustrate the desirability of written employment agreements. But agreements can be desirable even in companies that are not prone to disputes.
Consider these situations common to family businesses. Members of the second generation will quickly recognise the value of having an employment agreement. First, there are the general benefits of promoting clarity and better defined expectations. But an employment contract can also provide enhanced job security to a younger generation family member who may have given up another job elsewhere in order to be part of the family enterprise. Without the promise of a multi-year commitment, the star protégé may be hesitate to change careers.
The founder may also benefit from having an employment contract. Facing insecurities that are different than – but parallel – to those of the second generation, the founder is entitled to financial security as he or she enters semi-retirement and the uncertainty that comes with transferring ownership of the company. From the company's perspective, it will usually be worthwhile to give incentives to its senior members to help transition company ownership and to sign a noncompete agreement that they won't attempt to steal away its key customers.
Finally, written employment agreements may be critical to recruiting and retaining non-family senior management. Leon Danco, a pioneer in family business consulting, spoke of the importance of non-family managers as a bridge to succession in family businesses. But non-family executives may be wary of family-owned companies, understandably anxious about limited advancement opportunities. When An Wang chose his son, Fred, to succeed him as president of Wang Laboratories, dozens of managers submitted their resignations in frustration. To attract and hold onto valuable non-family employees, family-owned companies should institute personnel practices that emphasise objectivity and professionalism, including market rate compensation, regular performance evaluations, job descriptions and, of course, employment agreements.
Whether complex or straightforward, a standard form or a highly individualised document, an employment agreement typically addresses some basic factors. The provision spelling out the employee's position and duties would include the employee's title, reporting position and lines of authority, and an abbreviated job description. From the company's perspective, some flexibility should be retained since a director of marketing, for example, might subsequently be asked not only to oversee the sales force but also to work with the head of research and development on creating a new product line.
Compensation is generally defined in terms of a base salary in weekly, monthly or annual increments and subject to withholding taxes and other deductions. Bonuses, whether discretionary or based on the fulfillment of targets, may also be part of the package. The challenge in a family firm is to tie the compensation of family members to a rough approximation of the individual's market value, seeking to neither make a gift by overcompensating nor to extract a price for the privilege of working in the family business by undercompensating.
As an adjunct to compensation, fringe benefits offer the employee a wide array of extras, which may include paid vacation and sick days, health and dental insurance, life and disability insurance, pension benefits, an automobile allowance and various perks. The contract may indicate that the benefits will be "the same as are offered to other senior employees" since such benefits are likely to change over time, for better or worse.
The contract may be for a fixed term, such as one or more years, or may be terminable by either the company or the employee "at will". Even most fixed term contracts will provide that they can be terminated by the company for "cause". The definition of cause in the contract will be negotiated by parties who are well-represented, since the employer will want scope to sack an employee whose performance is found lacking, while the employee will want a more objective standard with notice and an opportunity to cure any offending behaviour. Severance pay, if any, is a related topic frequently negotiated upfront.
Finally, but of substantial importance in many companies, the employment agreement provides an opportunity for the company to protect itself by requiring the employee to agree to confidentiality and noncompete obligations. Except for the overall advantage of clarity, most other aspects of a written employment agreement favour the employee more than the company. With a confidentiality or non-disclosure provision, the company can protect its trade secrets, including customer lists, technical know-how and financial information. Employees may also be asked to confirm that all inventions created during the employee's tenure at the company belong to the company.
A non-compete will then restrict an employee from going to work for a competitor, and from soliciting the company's customers, for some time after employment terminates. In most jurisdictions, non-competes will only be enforced for a limited period of time, such as one year, and only if the courts find them "reasonable" in terms of the geographic and industry restriction on the employee's right to earn a living.