How Should a Family Business Pay Relatives Who Own Shares but Do Not Work There?
Short answer. Treat pay for work and returns on ownership as separate matters. A relative who does not work in the business generally receives value through the shareholder rights and distribution policy attached to their shares. Set those rules consistently for all owners, document them, and consult your attorney or CPA on legal and tax specifics.
Keep pay for work separate from the financial returns of owning shares. A relative who does not work in the business should not receive a salary for a job they do not perform. Their financial return should follow the company's ownership and distribution rules, applied consistently to shareholders in the same position.
Distinguish Employee Pay From Owner Returns
Salary compensates an employee for defined responsibilities. Ownership may carry rights to distributions and voting, along with other benefits under the company's governing documents. Make sure company records and family discussions distinguish these categories. This helps avoid using payroll to resolve disagreements about ownership or to make one shareholder feel favored.
Set clear dividend or distribution rules that account for the company's operating needs and cash requirements, as well as its obligations to shareholders. The policy should explain who approves distributions and how the decision is recorded. Owners can agree on a regular process for reviewing the policy, while leaving room to consider the business's financial position. Talk with your attorney and CPA about the legal and tax treatment that applies to your company and its shareholders.
Use the Ownership Documents
Review the shareholder agreement and share register, along with other governing records, to confirm who owns what and what rights attach to each class of shares. Keep ownership records current when shares transfer or pass through inheritance. If the documents are unclear or no longer reflect the family's needs, get qualified legal advice before changing distributions or rights.
Use the same rules for relatives in equivalent ownership positions. Differences may exist between share classes or under agreed terms, but the basis should be documented and understood. Avoid making informal payments to individual family members from company funds. A transparent approval process and accurate records help owners see that payments follow the company's rules.
Give Owners a Way to Discuss the Policy
Shareholders who do not work in the business still need a channel to understand its performance and raise questions. Provide appropriate reporting on the company and explain how distribution decisions are made. Keep the discussion focused on ownership rights and the business's capacity to pay. Do not compare one relative's personal needs with another's.
If family members disagree about the amount or timing of distributions, use the agreed governance process and document the decision. Changes to ownership rights, dividends or share transfers can have legal and tax consequences, so consult your attorney or CPA before making them. Related topics include balancing reinvestment and family distributions, handling disagreement about dividends, shareholder agreement terms, and setting compensation for family employees.
A term sheet covers how many shares are being offered, the price per share, common or preferred share status details, preferences, pro- rata rights, participation rights, pre-emptive rights, conversion rights, and board rights.
Sources: The Single Family Office. Informational only, not financial, legal or tax advice.