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    7 Replies Latest reply on Apr 20, 2012 6:10 AM by laurieed2002

    When buying a business how do you figure what your compensation will be?

    laurieed2002 Adventurer

      I have been 'kicking the tires' on a few businesses for sale.  The one question I keep coming up with as I dig a little deeper is this:  I will be financing the purchase, so how do I figure how much compensation I will receive after servicing the loan?  I know this sounds like it would have a straight forward answer but it seems it is alluding me for a couple of reasons.  The first is this, when does the owner of a business typically get paid, monthly or at the end of the year?  The second part to that is, if the owner doesn't get paid until the end of the year, how do I service the loan and have money each month to live off of?  I have seen some worthwhile businesses but I always scare myself off when I do a quick amortization on the loan, and realize that almost all of the net income would be going towards servicing the business loan which would leave me with very little to live off of.  I understand that is one of the factors an entrepreneur has to live with, business first, owner second but I have read several blogs and articles stating that if there isn't something left over, moneywise, for the owner that you very soon find yourself floundering and feeling defeated and disgruntled.  I appreciate everyone's input on this and I look forward to reading them all!  Thanks....  Ed

        • Re: When buying a business how do you figure what your compensation will be?
          ArcSine Scout

          Generally, the owner takes compensation when and as the business's cash flow allows. This could be quarterly, semiannually, weekly, or any other frequency, depending on the nature of the business, its revenue pattern, and its expenditures obligations. Further, it's possible for the owner's compensation to be on an irregular pattern, of varying amounts, until the company reaches a point of stable and predictable net cash flows.

           

          It sounds like you're in the market for an existing, established biz, in which case you'll generally have the benefit of history to give you a better idea of what your cash flows (and thus compensation pattern) might be post-purchase. If the business is generating enough net cash every month to service the debt, then it's less likely you'd have to come out of pocket to make a loan payment (subject, of course, to the possibility of experiencing a down month and a resulting cash shortfall).

           

          Regarding the issue of the biz's cash flows being just barely enough to service the debt, keep in mind that the amount of the monthly loan payment is a function of two things (primarily): (1) the size of the loan; and (2) how fast it's being paid off.

           

          (1) is directly tied to the amount you're paying for the business. If the loan has a reasonable maturity (i.e., Item (2), you're not trying to pay it off very quickly) and yet the biz's profits are barely enough to service the debt, it might indicate that you're looking to overpay for this company. (Emphasis on "might", as there are a boatload of situation-dependent factors that have a hand in this issue.)

           

          Re (2), on the other hand, some business buyers have a strategy of acquiring companies whose cash flows can support a rapid paydown of the debt. They live with the fact that they'll receive minimal compensation for the first X years (with X being an acceptably small number), with the expected upside of having a debt-free company after X years which is throwing off strong cash flow (all of which is going to the owners' pockets, of course, after the debt has been paid off.)

           

          Another factor is revenue and cash flow growth. Are you seeing this forecast of "barely making the mortgage payment" as merely a short-run phenomenon while the company works to grow its revenues and profits, or does your crystal ball show it to be a chronic long-run condition? If the latter, it's quite possible that the business is overpriced---and hence the loan is too high relative to the company's bottom line.

           

          Again, the correct analysis in any given scenario turns on a number of situation-specific variables, but maybe the foregoing will help a little bit. Best of success with your goals!

          1 of 1 people found this helpful
          • Re: When buying a business how do you figure what your compensation will be?
            UncleLeon Scout

            I respectfully disagree with Arcshine.

             

            Your income from the business will come from two sources.  One is the salary you Draw.  The second is the Profit of the business.

             

            To establish your salary, you should consider two things.  One is how much you need for you personal income.  The second is what is a normal and reasonable salary for the position you will hold.

             

            I recommend that you draw that salary on a regular basis, such as weekly, semi-monthly, monthly, etc.  I suggest that you draw a salary whether the business can afford it, or not.  Then, if the business can not afford it, simply lend back to the business the funds you wish to lend, keeping track of it, for accounting purposes and also TO KNOW, EXACTLY, what your business is doing. 

             

            I realize that (in a way) it seems ridiculous to take out money and then put it back.  But if you don't do this, for the sake of proper accounting, you may have a false sense of profit.

             

            Concerning the profit distributions, I suggest that each quarter you look at the condition of your business, the business needs for both paying bills, and the future needs (for the next quarter) insofar as anticipated growth, inventory, etc) and by that consider what funds must be left in the business as "cash reserves".  The balance of funds can be distributed to the owners as profit distribution.

             

            When considering the purchase of the business, I believe that the SBA guidelines are ideal.  That is:  The business should be able to generate enough funds to operate; to pay the owner a reasonable salary as an owner/manager; pay the debt service; and still have a 20% additional cash flow safety net.

              • Re: When buying a business how do you figure what your compensation will be?
                Moderator Cath Guide

                One of the great features of this community is to disagree in a civil manner and offer another opinion.  ThanksUncleLeon, for your comments in this issue.  I hope others will feel free to join in and let us know your feelings. One of the best ways to improve in business is to have healthy discussions.

                 

                Thanks to everyone for taking time to respond on threads you feel you have some expertise in.  Your comments are respected and appreciated.

                 

                Cath

                • Re: When buying a business how do you figure what your compensation will be?
                  ArcSine Scout

                  Hey, I dig a little stimulating disagreement as well as the next guy, but at least get the name right If I wanna be called funny names I get plenty of that already from Mrs. Arcshine...er, ArcSine. You were probably just thinking of my brother-in-law Moon Shine, or his son Sun.

                   

                  I agree with UncleLeon in principle; it's just in the implementation of the principle where we diverge. Fundamentally, a business isn't profitable unless its pre-salary net earnings > the fair-market salary value of all personal services being rendered to the company, including any from the owner. One implication thereof is that if a business generates positive cash flow sufficient to pay the owner a salary, but one which is less than a fair salary commensurate with the owner's labor, then than biz is operating in the red in an economic sense (even though it's profitable by accounting measures).

                   

                  So far we're singing the same tune. But I don't necessarily think, though, it's mandatory to make this economic loss physically explicit via the "salary payout with immediate re-loan back" mechanism. I concede that it could be a helpful monitoring tool for certain biz owners who really need to have the picture right up their face. If so, cool; you do whatever it takes to give the owner a clear picture of the company's true economic performance.

                   

                  But plenty of other business owners--including many I've dealt with personally--are pretty good at doing that math in their heads. If a guy is able to pull 7K a month out of his company, while always aware of the fact that he could be making twice that amount as an engineer employed at a large firm, he's keenly aware that his entrepreneurial drive is costing him about 7 g's a month, hard cash. No false sense of profit there.

                   

                  The "salary / loanback" mechanism will invoke additional bookkeeping entries, and might induce a build-up of numbers on the balance sheet across time. Both of these things carry an accounting and analytical cost. So while I agree that the physical "salary / loanback" strategy might indeed be helpful to some biz owners, I'd suggest making sure on a case-by-case basis that it's actually needed enough to justify the incremental cost and complexity.

                   

                  Cheers!

                    • Re: When buying a business how do you figure what your compensation will be?
                      laurieed2002 Adventurer

                      Thank you ArcSine for all of your input thus far.  I also appreciate everyone who has contributed to this discussion.  I have acquired the services of a business broker to help me search (most of the businesses for sale on the web are not current and are either already sold or under contract) for a suitable business.  I have also been utilizing the local SCORE chapter to gain insight from some seasoned business professionals. Once again thank you ArcSine and all the rest who have contributed....