Quick Consultant: Minimum Owner's Salary Required to Establish Business Value

If space permitted, I would clearly be appending these remarks to note that while some of the figures in this table may appear quite modest or even low, the very best companies in this industry (the top 25%) report owner’s compensation figures in the 18-24% of annual sales. A few report even better numbers.

However, claims by some folks that they are making 30-34% or more have to be taken with a huge grain of salt. At the other end of the spectrum, at least in terms of owner’s compensation, there are companies in the industry that are struggling just to remain in the “positive” column.

The Fair Market Salary column (column #3) is used in many valuation scenarios as well as in the NAPL Benchmarking Report to convert owner’s compensation into a more accurate representation of true profitability.

Traditionally speaking, the term profits represents all the money that is left over after paying all the expenses of the business. One of those expenses is indeed fair market salaries for owners and officers. So, before we can report on the true profitability of a company, we must first make some allowance for paying the owner a fair salary.

We do that by using a long accepted formula, which calculates a fair market salary for an owner as: Fair Market Salary = (4% of Annual Sales + $14,000) x 1.18

The multiplier of 1.18 is used to account for additional payroll taxes and benefits paid to and on behalf of a single owner. Thus, a fair market salary for the owner of a company doing $1 million in sales would be $40,000 + $14,000. That $54,000 multiplied by 1.18 equals $63,720. (See chart)

Excess Earnings Represent Value

Industry benchmarking studies and previous Operating Ratio Reports produced by NAPL have used this fair market salary formula when calculating return on net assets and excess earnings.

While the salary paid to an owner is important, it is excess earnings, or the amount that is left over after allowing for a fair market salary, that is the more reliable indicator of true value in a company. Investors will examine closely these excess earnings, and typically will apply a multiplier, ranging between two and six to arrive at initial valuations. Of course, the value of the assets being sold is typically factored into the valuation, but excess earnings, and not assets, typically represent the bulk of value in most companies.

One last important thing to note: it is quite possible for a company to actually report negative excess earnings because some companies simply do not make enough money to even satisfy or reach our fair market salary threshold, let alone produce excess earnings. In those situations, the value of a company, aside from its assets, can drop to almost $0! Senior contributing columnist John Stewart is president of Q.P. Consulting. He is co-author of the industry best seller “Print Shop For Sale”. Go to www.printshopsforsale.net for a good Q&A on business valuations. Follow John’s blog on his website at thequickconsultant.blogspot.com.Contact him at 2110 S. Dairy Road, West Melbourne, FL 32904, call 321-727-2444, or email qkconsult@aol.com.