One key step in business valuations, often misunderstood, is adjusting for owner pay.

In many SMEs, the owner's salary and benefits often don’t match what an independent manager would earn. They may pay themselves less than the market rate to run the business. Owners might earn less income as the business grows. Or, they could take more through salary, dividends, or personal expenses.

When valuing a business, we need to address these differences.

The goal of a valuation is to find the business's maintainable earnings, not just what the accounts show.

That means owner remuneration often needs to be normalised.

Why Owner Remuneration Matters in Business Valuation

Most SME business valuations are based on some form of earnings methodology, such as:

• Capitalisation of Maintainable Earnings

• EBITDA multiples

• Discounted Cash Flow (DCF)

These approaches rely on estimating the sustainable earnings of the business. However, owner-managed businesses often contain distortions such as:

• salaries that are above or below market rates

• family members on payroll

• personal expenses paid through the business

• dividends replacing salary

• profit distributions instead of wages

If these items are not adjusted, the valuation may misrepresent the true profitability of the business.

The Concept of “Market Salary”

A key change in business valuation is figuring out the cost to replace the owner with a skilled market-based manager.

This is often referred to as a replacement salary or market remuneration.

The objective is simple:

What would the business have to pay someone to perform the owner’s role if the owner was not involved?

This figure should reflect:

• the size of the business

• the industry

• the complexity of operations

• the responsibilities of the role

• geographic location

Once a reasonable replacement salary is set, we can adjust the financial statements.

Example 1 – Owner Paid Below Market Salary

Consider a consulting business generating $1,000,000 in revenue and $300,000 in net profit.

The owner currently takes a salary of $80,000 per year. Market data shows that a professional manager in the same role would earn about $180,000 a year. To determine maintainable earnings, we adjust the profit to reflect the market salary.

Reported profit: $300,000

Adjustment for owner salary: ($100,000 additional salary required)

Maintainable earnings: $200,000

If a valuation multiple of 4x earnings is applied:

Reported profit valuation: $300,000 × 4 = $1,200,000

Adjusted valuation: $200,000 × 4 = $800,000

This example shows how owner remuneration can materially affect business valuation outcomes.

Example 2 – Owner Paid Above Market Salary

In some businesses, owners extract value primarily through salary. Suppose a business reports:

Revenue: $3,000,000 Profit after owner salary: $100,000

The owner is paid $400,000 per year, but market salary for the role is estimated at $200,000.

To determine maintainable earnings:

Reported profit: $100,000

Add back excess salary: $200,000

Adjusted maintainable earnings: $300,000

If the business trades at a 4x earnings multiple:

Valuation = $300,000 × 4 = $1,200,000

Without this adjustment, the business would appear far less valuable than it actually is.

Salary vs Dividends

Many business owners organise their income using salary, dividends, and trust distributions.

From a business valuation perspective, the key question is not how income is structured for tax purposes.

Instead, the focus is on:

What level of compensation would be required to run the business independently?

The business valuation should normalise earnings, whether income comes from wages or distributions.

Personal Expenses Through the Business

Another common issue in owner-managed businesses is personal expenses recorded as business costs.

Examples include:

• private vehicle expenses

• travel unrelated to business operations

• family wages not aligned with commercial roles

• home expenses

• lifestyle items such as boats or recreational vehicles

During a valuation, these expenses are often adjusted as normalisation adjustments.

For example:

If a business reports:

Profit: $250,000

But includes $50,000 of personal expenses, the adjusted earnings may be:

$250,000 + $50,000 = $300,000

These adjustments help present a clearer picture of the underlying economics of the business.

Relevance in Transactions and Disputes

Owner remuneration adjustments are particularly important in situations such as:

• selling a business

• partner buy-outs

• employee buy-ins

• family law matters

• shareholder disputes

• employee share schemes

• business restructures

Both parties need to be confident that the earnings in the business valuation show economic reality, not just tax structuring.

Strategic Perspective

Business owners often view remuneration primarily through the lens of tax planning.

However, from a business valuation perspective, the focus shifts to commercial economics.

A well-prepared business valuation separates:

• tax-driven income structures

• personal expenses

• commercial operating earnings

This allows investors, buyers, or courts to understand the true profitability of the business.

Final Thoughts

Owner remuneration plays a critical role in determining the value of an SME.

Many owner-managed businesses don’t pay market salaries. Financial statements often need adjustments. We do this before starting the business valuation analysis.

These adjustments help find the business's maintainable earnings. This is the base for most business valuation methods.

Handled properly, remuneration adjustments produce a clearer and more defensible view of value.

Handled poorly, they can materially distort the outcome.

At RJD Advisory, we analyse at owner pay, normalise financial statements, and determine maintainable earnings. This way, business valuations show the real economic performance.

Clear financial analysis. Defensible valuations. Better decisions.

📞 Book a free consultation today to discuss a business valuation.