Owner's Salary

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January 16, 2024

by a searcher from Harvard University - Harvard Business School in Miami, FL, USA

When valuing a company, I understand the correct thing to do is to remove the current owner's salary (and any other salary that will no longer be necessary) and add the salary for a new manager if necessary (which would be myself).

Is this generally correct?

What is a reasonable salary to include for oneself? How should this be calculated?

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Reply by a searcher
from Georgia Institute of Technology in Pittsburgh, PA, USA
Yes, you’re thinking about it the right way — this is a standard part of moving from Seller’s Discretionary Earnings (SDE) to a more buyer-focused view like EBITDA or true cash flow. You back out the seller’s salary and any personal/non-operational expenses, then add in a market-rate salary for whoever will be filling that role post-close — whether that’s you or someone you hire. As for what salary to include for yourself, it depends on: Market rate for the role you’ll be performing (GM, CEO, etc.) in that size of business and industry Your own opportunity cost And importantly, what the business can afford while still hitting your debt service and return targets Some searchers set their salary as the lesser of (1) market comp or (2) what’s reasonable after covering debt service and minimum working capital. Others benchmark against SBA underwriting standards, which often assume a ~$100K salary for the operator in cash flow models. Ultimately, it’s a balancing act — you want to be realistic about your own time and responsibilities, but not overstate profitability by undercompensating the post-close operator (even if that’s you).
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Reply by a searcher
from Tufts University in Jersey City, NJ, USA
Others have done a good job of clarifying that the adjustment needs to be made on the basis of "fair market"/replacement cost for an owner-operator, Regardless of whether you plan to step into that role yourself or hire someone into it, this allows you to properly segment the owner-operator salary (which is a business expense, reducing cash flow to beneficial owners) from profit.

An important thing to keep in mind: Even if you're making this adjustment properly, if you're providing immediate or near-term exit for the owner-operator and not planning on filling that operator role yourself it is critical to make sure you're confident that you actually can hire someone into that role who can act as equal (or better) replacement. Just because you earmark enough financial resources to hypothetically hire replacement, finding the right operator might not be a trivial undertaking depending on the business/industry and could potentially require further alignment of incentives (equity, bonus structure, etc) in addition to the salary that you include in your underwriting.
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