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Generosity may nip your acquisition value

Recently, we had a client who was very generous with bonuses to his employees. For the company’s three previous years, as a reward for his employees’ hard work during COVID-19 and through the supply chain issues (and because he had an epic 2022), his company distributed hefty bonuses. As he was giving these out, the owner was clear with the employees that the bonuses might not always continue at the higher level, if they continued in the future at all. “Enjoy it now, because it might not happen again,” he said.

After three years, the owner decided to revert to a bonus structure that wasn’t so generous, but still solid. He went to a straight 5% of base salary. The employees were all onboard. Then, coincidentally, the owner decided to sell the business. On the financial reports we prepared for offering the company for acquisition, it was obvious how much the bonuses had been, three years running. It was also obvious that the bonuses were going down in the current year (the year of potential acquisition).

The problem arose when prospective acquirers started to look over the company, and they saw a clear pattern of past bonuses. They also looked at the planned 5% bonus plan, and they squinted really hard and said: “Why are you taking away compensation that had been a multi-year pattern?”

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The reason for their question is simple: New owners rarely want to go backward on compensation when they buy a new company. The new owners don’t want to be in the role of bogeyman, swooping in, taking control, and immediately lowering bonuses or comp in any way. They are worried that this will generate poor morale among workers, or worse, inspire workers to quit.

Even though our client was careful to warn the employees that the fat bonuses were “just for a few good years,” the prospective buyers wouldn’t have any of that; they wanted the comp to continue at a high rate. The prospective buyers’ wishes were met with protests from the seller, who stated, in all sincerity, that the employees were all-in on the new bonus plan and that he wasn’t going to the 5% bonus in the year of sale just to fatten up the EBITDA line.

Here’s other potentially bad news for the seller: Let’s say that the bonuses for each of the last three years totaled $1 million/year, but the new 5% bonus plan totals just $200,000. The prospective buyers may very well insist on reducing EBITDA by $800,000 (the difference between the new lower bonuses and the historical $1 million), under the assumption that the new owner would restore the fatter paychecks.

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How does that affect value? Dramatically. Solid companies today are selling between 5X and 6X of adjusted EBITDA. (The higher multiple is likely achieved for companies that have EBITDAs north of $5 million, and/or smaller companies that have extraordinary EBITDA and gross profit margins.) If the seller lacks leverage, and the buyer prevails in arguing for the $800,000 reduction in

EBITDA, you multiply that figure times five to see the reduction in purchase price of $4 million dollars. Ouch! (Or multiply it by six to see a reduction of $4.8 million.)

I can already hear my readers screaming: “All because the guy was generous, and did the right thing with his employees, and he takes a multi-million hit!?”

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Well, as the old saying goes: Life isn’t fair. (All we can hope for is that it is predictable.)

In a market on the bubble right now, between being a buyers’ market and a sellers’ market, the seller can hope only for multiple suitors, so that either a) the pressure for the negative EBITDA is not as much of an issue or b) that a compromise can be reached.

No matter the outcome, be aware: 1) Prospective buyers are resistant to sliding backwards on comp. 2) When a negative adjustment to comp happens close to the time period when the company is seeking acquisition, sellers and their bankers should prepare a solid case as to why the EBITDA should not be reduced.

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