Depending on your corporate structure, most company owners—who are also employees of their own company—will take a salary and bonus. These two types of expenses should be logged as OPEX in your P&L.
Like any OPEX, the salary and bonus have a dollar-for- dollar impact on the Adjusted EBITDA. If you reduce a dollar of OPEX, you pick up a dollar of Adjusted EBITDA. For example, let’s say that you, the owner/employee, take $200,000 in salary, reported on your W2. If you give yourself a raise to $250,000 in the next fiscal or calendar year, that $50,000 will reduce the EBITDA for that time period by $50,000.
From the point of view of a potential acquirer, you should be paying yourself “fair and customary” compensation, salary and bonus combined.
But what is “fair and customary” compensation? It’s sensitive to your responsibilities, sales revenues, and location. To find yours, go to Perplexity.AI and ask for the “fair and customary” comp rates for your circumstances and location. Perplexity will send you to ZipRecruiter or similar sites, where you’ll find the “swim lanes” for your all-in comp.
If you are seeking an acquirer, and you are either over or under the “fair and customary” rate for your position, it could result in either a negative or positive adjustment to EBITDA.
Let’s say you are in pricing negotiations for the sale of your company, and the acquirer is using “dynamic pricing.” This means the acquirer has offered a multiple of Adjusted EBITDA that will be applied to the trailing-12-month Adjusted EBITDA from the financial statements closest to the closing date. Let’s say that multiple is 6X.
During due diligence, the acquirer will examine the total comp of the owner/employee. If it is too low compared to “fair and customary,” the acquirer can ask for it to be raised in the Adjusted EBITDA model. For instance, if you are paying yourself $100,000 and you should be paying yourself $250,000, that $150,000 difference will be deducted from the Adjusted EBITDA. Here’s why: That additional $150,000 is what the acquirer will have to pay for your role under new ownership, or what they’d pay to hire your replacement. That $150,000 Adjusted EBITDA reduction times 6 means a lowering of the purchase price by $900,000! Hate to break it to you, but the acquirer has you dead to rights that the Adjusted EBITDA on which the acquisition value is based had not been reflecting fair compensation for your role. You, the seller, will get dinged as a result.
If the owner/employee comp, is too high, the reduction in that compensation will raise Adjusted EBITDA; however, don’t always count on the acquirer to point that out. In fact, it’s your investment banker’s job to do that, well in advance of reviewing LOIs. Adjusting owner/employee’s comp that is too high is a widely accepted adjustment to EBITDA. Say you add $50,000 to Adjusted EBITDA, if you were overpaying yourself that amount in a “fair and customary” review. This will juice the Adjusted EBITDA, and your purchase price would increase by 6X $50,000 for that adjustment alone. Ka-ching.
For owners of privately held companies, there are several corporate structures that allow you to take dividends. The corporate structure can influence how dividends are distributed and taxed. The IRS requires that you take “reasonable compensation” as a company employee, and the salary should be in line with what similar companies pay for comparable services. Qualified dividends may be taxed as preferential capital gains rates, at 0%, 15%, or 20%, depending on your tax bracket. Unlike the “W2 comp” (salary and bonus) that you report as OPEX on your P&L, dividends come off your balance sheet (usually distributed after year-end books are closed). Dividends are not OPEX on the P&L.
Worried that you are leaving cash on your balance sheet when selling your company? Don’t. Almost all deals are sold on a “cash-free/debt-free” basis. So, the cash and cash equivalents on the balance sheet at the time of sale are the seller-owners’ to “sweep” before the closing, as long as the net working capital peg is satisfied.
