What is Adjusted Owner Benefit?

Adjusted Owner Benefit

The adjusted owner benefit is the standard way by which business brokers express what is commonly perceived as the net profits of a business that is being advertised for sale. Some business brokers refer to the Seller’s Discretionary Earnings (SDE) when referencing the adjusted owner benefit. There is a large difference, however, between the SDE or adjusted owner benefit of a business and the ‘net profit’ of a business that appears on a tax return (as taxable net profits) or at the end of a profit and loss report (as net income).

True Economic Profits for Working Owner

The adjusted owner benefit refers to the true amount of economic profits derived by a working owner of the business. In order to determine the adjusted owner benefit, one can start by examining the company’s financials and calculating the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).  The EBITDA must be adjusted further, however, in order to uncover the true economic profits of the business as derived by a regular working owner under ordinary conditions.

Adjust EBITDA to Reflect True Owner Benefit

Major adjustments or add-backs to EBITDA include the owner’s personal expenses that flow through the financials as business expenses, rental adjustments to reflect current occupancy costs, and the owner’s salary along with salaries of the owner’s family. Unrecorded cash (if proven) may also be added back to a financial statement in order to derive the adjusted owner benefit. Business valuations are based on the adjusted owner benefit, so it is a good idea to fully understand this critical concept before selling your business.

Adjust Owner Benefit for Owner’s Personal Expenses

Probably the most common of all adjustments for small businesses, the owner’s personal expenses that are expensed as business expenses in the financial statement must be added back as an owner benefit. Such expenses are not business expenses but rather are of direct economic benefit to the owner. For example, say the owner of an auto shop purchases a sailboat for $200K. Then the owner uses that $200K expense as a business expense in his financial statement (such as a tax return or profit and loss statement). So long as it can be verified that the $200K expense was not used for business purposes (but rather for the owner’s benefit), then the $200K should be added to the adjusted owner benefit.

Lenders Typically Do Not Count Personal Expenses as Owner Benefit

Many buyers of businesses use lenders backed by the Small Business Administration (SBA) in order to fund their transactions. As a part of the lending process, the SBA will evaluate and determine their value of the business. This valuation process and result may differ dramatically from what the buyer and seller of the business agree upon. Lenders do not typically count the owner’s personal expenses as being part of the adjusted owner benefit. Very seldom will a lender have an open mind and a willingness to go through the laborious process of verifying whether a company’s ‘business expenses’ on its tax returns or profit and loss statements are in fact the owner’s personal expenses.

Adjust Rental Costs to Reflect Reality

Some businesses have attached real estate which comes with the business. In such instances, business brokers must determine the fair market value of the monthly rent for the property (this should approximate the monthly costs of a mortgage and upkeep on the property). Then the business broker must determine how much rent (if any) the business paid (to whichever legal entity that owns the property) in its financial statement. The rental costs (if any) on the financial statement should be adjusted to reflect the actual fair market value of rent for the property.

Rental Adjustments to Owner Benefit if Seller Keeps Property

Also note that some business owners own attached real estate (such as a restaurant owner who owns the building where the restaurant operates), but wishes to keep the real estate and rent the property to the buyer of their business. In such circumstances, the rental expense on the company’s financial statement should be similarly adjusted to reflect the rent that the seller is seeking from the buyer for use of her property after the sale.

Adjusted Owner Benefit Includes Owner’s Salary

Many business owners choose to pay themselves as W2 employees. The owner’s salary is considered an economic benefit to the owner, and it is considered standard practice in most industries to have one active or working owner. The salary paid to this owner is then part of the adjusted owner benefit. Working business owners with special skills and which a buyer can not replace by their own labor may not fully include their own salary as a part of adjusted owner benefit. Instead, the owner’s replacement cost must be determined and weighed against the salary paid to the owner in the financial statement.

Salaries for Owners’ Family Members Must Be Adjusted

If a business has multiple working owners or working family members of the owner, then it is not typically considered standard practice to include all of their salaries as a part of the adjusted owner benefit. Buyers can not be expected to replace more than one working owner or working family member by themselves, and would need to incur labor replacement costs in order to do so. The salary expenses (for everyone but the owner) on the company’s financial statement must be adjusted to reflect the costs to replace the labor of everyone but the owner. If anyone receiving a salary is not actually working in the business, then such labor costs are entirely considered to be an owner benefit (as the owner is deriving economic benefit from giving someone of their choosing salaries out of the business).

Other irregular expenses (such as legal expenses) that an owner of a business may incur but which a buyer of the business will not incur are also considered a part of the adjusted owner benefit. Determining the adjusted owner benefit of a business is not an easy task, and requires the assistance of a professional business broker. In general, the owner’s personal expenses that flow through the financial statement, the owner’s salary, and adjustments to the rental costs all should be reflected in the adjusted owner benefit.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.

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