Owner Mistakenly Forgets Wife's Salary (Part 2)
As noted in the previous blog, the initial valuation for this company was quite healthy, but it had been predicated on information provided by Chris, the owner.
Just prior to my sending off the valuation, Chris casually mentioned, for the very first time, that his wife, Cathy, was actively involved in the business. However, no where in the list of employees or salary breakdowns had there been a hint that this was the situation. This was a major oversight on someone's part. I'll take at least part of the blame for failing to double-check with the owner if his spouse was involved in the business. It won't happen again.
So what did that oversight do to the value of the business? The valuation, which had originally been pegged at approximately $335,000 dropped to approximately $205,000! How could that happen?
Without boring you with details, once it was discovered that the original owner's compensation claim of $100,000 included compensation for the spouse, that figure had to be reduced by a fair-market estimate of what a new owner would have to pay to hire someone to replace the spouse. We agreed we might be able to find someone to handle the tasks performed by Cathy for $14.50 per hour but with taxes and benefits that totals approximately $35,500 per year. Consequently, the original owner's compensation of $100,000 was now reduced to $64,500!
Our valuation method, like many, relies on a multiplier that is applied to what we term "excess earnings." So as not to bore you with details, suffice it to say a reduction of $35,500 in owner's compensation actually results in a decrease in a company's valuation by three to five times that amount. In this specific situation, the adjustment we made resulted in a decrease in value for this company of approximately $125,000!
As we've often joked at seminars, the only way this adjustment or decrease in valuation could be avoided would be if when the sale of the business is concluded, it is agreed that Cathy actually comes with the business (just like the presses and copiers being purchased) and she will work for free!
Remember, what you and your partner or spouse take out of the business should never be confused with owner's compensation - these are two different calculations.
P.S. You can subscribe to this blog and read new entries as they are posted by using the button near the upper right hand corner of this blog, just beneath the "archives."
Just prior to my sending off the valuation, Chris casually mentioned, for the very first time, that his wife, Cathy, was actively involved in the business. However, no where in the list of employees or salary breakdowns had there been a hint that this was the situation. This was a major oversight on someone's part. I'll take at least part of the blame for failing to double-check with the owner if his spouse was involved in the business. It won't happen again.
So what did that oversight do to the value of the business? The valuation, which had originally been pegged at approximately $335,000 dropped to approximately $205,000! How could that happen?
Without boring you with details, once it was discovered that the original owner's compensation claim of $100,000 included compensation for the spouse, that figure had to be reduced by a fair-market estimate of what a new owner would have to pay to hire someone to replace the spouse. We agreed we might be able to find someone to handle the tasks performed by Cathy for $14.50 per hour but with taxes and benefits that totals approximately $35,500 per year. Consequently, the original owner's compensation of $100,000 was now reduced to $64,500!
Our valuation method, like many, relies on a multiplier that is applied to what we term "excess earnings." So as not to bore you with details, suffice it to say a reduction of $35,500 in owner's compensation actually results in a decrease in a company's valuation by three to five times that amount. In this specific situation, the adjustment we made resulted in a decrease in value for this company of approximately $125,000!
As we've often joked at seminars, the only way this adjustment or decrease in valuation could be avoided would be if when the sale of the business is concluded, it is agreed that Cathy actually comes with the business (just like the presses and copiers being purchased) and she will work for free!
Remember, what you and your partner or spouse take out of the business should never be confused with owner's compensation - these are two different calculations.
P.S. You can subscribe to this blog and read new entries as they are posted by using the button near the upper right hand corner of this blog, just beneath the "archives."
posted by The Quick Consultant at
9:10 AM
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