Owner’s compensation is a key feature that is addressed in various ways in a CIM. Some variables affect how owner’s compensation is treated in a CIM. Some of these variables include how much salary the owner is receiving, the role of the owner in the business currently, and the owner's role following a transaction. Combining these variables will determine how owner’s compensation is addressed in the CIM. A key point that must be known is that distributions do not affect adjustments to owner’s compensation. Distributions do not affect the income statement of the business, so they are not to be considered when making adjustments for owner’s compensation adjustments.
Owner Exiting the Business Post-Transaction
The adjustment for owner’s compensation will always depend on the owner's salary and the owner’s role in the day-to-day management of the business. If the owner is active in the business and working day-to-day in the business, the salary adjustment will be based on what the market rate for an employee that fits the owner's role is fulfilling. For example, if the owner serves in the CEO role of the business, the market rate for a chief executive in the industry of the business will be used to adjust for owner’s compensation. The market rate is typically sourced from the Bureau of Labor Statistics. When an owner makes more than the market salary, any salary that exceeds the market salary will be added to the adjusted EBITDA. When the owner makes less than the market salary, the difference between the market salary and the owner’s salary will be negatively added back. The logic behind these adjustments is that since the owner is serving a role in the business, once the owner is gone, someone will have to be hired at or around a market rate, and the normalization of the salary accounts for the hiring of the replacement.
When an owner is not active in the business, the entirety of the owner’s salary can likely be added back. Since the owner is not serving a functional role in the industry, there will not need to be anyone hired to replace the owner, and the compensation that the owner currently receives will no longer leave the business.
Owner Remaining with the Business Post-Transaction
When an owner remains with the business, their salary and role are still the main factors in the adjustment. Owner’s compensation will then be treated similarly to when the owner leaves the industry, as the compensation will be adjusted based on the market salary for the position the owner will assume post-sale. This may, however be much less than what the owner is currently taking through salary, in which case, if the owner expects to continue making a certain amount, the compensation adjustment can adapt accordingly. Sometimes an owner will be taking their compensation solely through distributions. In this case, the entire market salary will have to be negatively added back since the owner will no longer be able to draw their compensation through distributions, and their salary will have to be expensed by the company after a transaction. When an owner makes the market salary and expects the salary to remain consistent post-sale, there will likely not need to be an adjustment for owner’s compensation.
An adjustment will have to be considered for all owners of a company, and the way the adjustment is handled could vary based on their respective roles, salaries, and intended roles following a transaction. However, once the adjustments to owners’ compensation have been made, it will show more accurately what the new owner of a company can expect in terms of EBITDA with the owner’s influence on the company’s earnings adjusted for.
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