Why is Seller/Owner pay so low?

September 19, 2021

by a searcher from Emory University - Goizueta Business School in Marietta, GA, USA

I'm seeing a common theme. I'm reviewing CIM's and the owner/seller pay is $120K or so (or less), with $1-2 Million in EBITDA. Since I'm leaving industry to acquire, I surmise that I will need to pay myself the seller's current salary in order to calculate the ROI model for post-acquisition. I understand that I may be able to negotiate with my investors a slightly higher salary, but why would the owner naturally suppress their own W-2 earnings? Is there some sort of tax benefit that I don't know about?

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Reply by a searcher
from Johns Hopkins University in Atlanta, GA, USA

As someone who owns the majority of a business I've built in that range (1-2MM EBITDA), I'll echo ^redacted‌ and ^redacted‌ as stating two key considerations. Entitlement taxes do add up quickly, and you can have a pretty good standard of living anywhere between $100k and $150k depending on what you take out, how it's taken out, and when you take it out. I think the largest change in perspective in moving from industry into business ownership is that you're not really paid a salary. Someone once said that the way to get rich is to put all your eggs in one basket, then tend that basket carefully. You have an investment. Do you believe in your investment? Is that the core thing on which you're working? As an investor, I'd ask why your standard of living needs are much higher than can be achieved at the levels mentioned, whether you're expecting to receive a reasonable return (your expected return should be well above 50%/year on every dollar you leave in the business for the first 4-5 years) or why you're feeling the need to diversify at such a low level of EBITDA.

Reply by a searcher
from Duke University in Virginia Beach, VA, USA

I looked at a janitorial firm a few years ago where the owner was paying himself about $50K per year, but taking distributions of $300-$400K per year. He also had his wife's Lexus on the books in addition to some other things. This is a bit risky with Uncle Sam... but it represents the "rents" (or owner benefit) that owner can extract from the firm that you're unlikely to be able to enjoy if you have other participating investors. You might think about this as an inefficiency of sorts... His firm was "worth" significantly more to someone who could acquire it with a similar "owner-operator" ownership structure than it could be to an operator with more diverse ownership. This has implications for how competitive you can be versus other buyers who may be willing to offer more since it's actually *worth* more to them in a sense.

I agree with Camille - what the owner is paying himself has little to nothing to do with what you should get paid. Yes, he's supposed to pay himself a "market rate" per the IRS (because they don't like the payroll tax avoidance), but everyone knows what's really going on.

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