Mark Pestronk
Q: A larger agency has made a tentative offer to buy my agency, which has been in business for many years and has a good reputation in our city. A valuation issue has come up: The tentative buyer will pay me a price based on a multiple of the last 12 months' net profits of our agency. To determine net profits, the buyer has already added back to profits expenses like depreciation, taxes, interest and personal-type expenses like my car payments. I agree with all that, but what about my owner's salary? Shouldn't it get added back to profits, as well, since I won't be staying more than a few months after a sale?
A: You have put your finger on an issue that is quite common. Since every dollar added back to profits will result in a purchase price that increases by a multiple of that dollar, adding back your salary and benefits will increase the purchase price, possibly very substantially.
For example, say the net profits of your agency are $200,000, and your salary and benefits come to $100,000. If the buyer will pay a price equal to four times the profits, the purchase price without that add-back will be $800,000, whereas the purchase price with your salary and benefits added back will be $1.2 million -- a very substantial difference.
Some serial buyers almost always add back the entire owner compensation on the grounds that the selling owner will probably not be needed very much after the sale. Indeed, some buyers would prefer that the selling owner leave as soon as feasible so that the buyer's corporate culture can be more easily brought to your former agency.
On the other hand, some buyers refuse to add back your compensation because you are indispensable or irreplaceable for a variety of reasons. Finally, other buyers add back just that portion of your compensation that exceeds what the buyer would need to pay someone to replace you.
My advice is for you to identify, before the sale, a current or prospective employee who can replace you after the sale. If that person is already on your payroll, then you have an excellent argument that your entire compensation ought to be added back to profits. If you or the buyer need to recruit that person, then you would add back just the portion of your total compensation that exceeds what that person would be paid by the buyer.
One more thing: In most acquisitions, there is an earnout element; i.e., at least part of the purchase price depends on future sales, revenue or profits of your former agency's staff, customer list or location. With an earn-out, a price based upon a multiple of profits is really just a target price, and you need to make sure that there is a good likelihood that the earnout payments will add up to the target.
To increase that likelihood, you may need to stay on, in which case it is reasonable for the buyer not to add back all of your compensation.