Owner/Operator model, impact on SDE for valuation and existing managers

May 16, 2022

by a searcher in Houston, TX, USA

I'm looking at a professional services business with a passive seller where the general manager that runs it is paid 20% of annual revenue as their salary, and all others are paid hourly at much more affordable rates. The seller says all of the employees including the GM want to stay on, but he wants to value the business net of the general manager's salary and sell the business to an owner/operator who will be a more hands-on operator.

My preference is a passive ownership model, and to keep the operation running as close to the same as it was pre-acquisition (including having the existing management team stay on). Do you think these buyer and seller preferences are fundamentally incompatible? Any creative ideas for how to make this work for both ends on valuation and with operating post-acquisition? One idea I had was to take out the revenue associated with this GM if we were going to take their costs out of the valuation as well.

Thanks for your input!

Reply by an intermediary
from Wisconsin Lutheran College in Brookfield, WI, USA

I would normally price a passive owner business at a higher multiple than an owner/operator. All things being equal, the price of an owner/operator multiple with higher cash flow should be close to that of the same business with a passive owner and lower cash flow. The way I see it is passive owners lend more to an EBIDTA multiple (higher) vs owner/operator with cash flow multiple (lower).

Now with an employee being paid 20% of top line revenue, that might not hold true. If that employee is well over market value, you probably have an issue. Which is likely why the seller is trying to add it back and generate a higher value. He may be trying to cover a mistake in overpaying that employee.

Reply by a searcher
from University of Pennsylvania in Charlotte, NC, USA

I would think before discussing hypothetical valuation approaches, you would want to determine whether paying 20% of revenue to the GM is a viable compensation model going forward. What are you getting for this extraordinary reduction of cashflow? What would be the GM's likely reaction if you were to propose a more reasonable salary/wage, and what risks or opportunities are presented by a possible management change?

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