Owner’s compensation normalization, explained simply
Owners of private companies often set their own pay for tax or personal reasons rather than market reasons. Some are paid well above the replacement cost of the role, and some far below. After a sale, the business must pay a market salary to whoever performs the role, so EBITDA is adjusted accordingly.
The adjustment can increase or decrease EBITDA.
Owner pay against market cost
Illustrative$ thousands per year
Alder Creek’s excess pay is added back. The second company’s owner is underpaid, so EBITDA is reduced.
Direction of the adjustment
| Situation | Adjustment |
|---|---|
| Owner paid above market | Add back the excess: EBITDA increases |
| Owner underpaid or unpaid | Deduct the shortfall: EBITDA decreases |
| Family members paid but not working | Add back their pay |
| Owner leaving and not replaced | Add back only if the role is genuinely not needed |
Worked example
Alder Creek’s owner takes $550,000 of salary and benefits. A hired CEO would cost about $300,000 including payroll taxes and benefits, so normalization adds back $250,000. At another company the owner takes $80,000 against a market cost of $300,000, so $220,000 is deducted, reducing value by $1.76 million at 8.0x.
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
How market pay is measured
- Salary surveys and compensation databases for the sector and region
- Recruiter quotes for the role
- Pay for comparable roles inside the company
Why it matters in a deal
Owner pay is often the largest single adjustment in smaller transactions and is frequently overstated in the seller’s favor.
Red flags
- An owner performing two roles but only one replacement cost included
- Market rates taken from a much smaller company or a cheaper region