M&A TRANSACTIONS: Considerations about the managing shareholders’ salaries in SMEs

Your adjusted EBIT is actually 700.000€, sorry.

You are the founder and CEO of a small or medium size enterprise (SME) in the digital space. The CFO and CTO co-founded the business with you some years back, and are currently full-time employees like you. The shareholding base of your business is still fundamentally in the hands of the three co-founders and the company has grown and now generates consistently 5€ million of revenue and over 1€ million EBIT each year. Prior to starting your company all of you had corporate jobs and were making healthy six figure salaries, but you had to adjust your earnings to a very basic wage when the company was in the start-up phase, over 6 years ago.

After only two years of activity the company started generating cash and you decided thar it was safer and more tax efficient to pay out dividend rather than increasing your salaries. It also avoided the uncomfortable discussion about how much each founder should be making, should the CTO be paid more than the CFO simply because good CTOs where difficult to find?

One bright and sunny day, Super Multinational Big-time market leader came knocking at your door. “Would you be interested in talking about strategic options?” they asked. “Yes, we would be delighted to chat about strategic options. We are so excited about this opportunity, we admire you and your company so very much” you answered, following the well-established script. Subsequently you signed and Non-Disclosure Agreement and started providing more information than you would have preferred to Super Multinational Big-time market leader, and to Bob the smiling financial advisor with the slick hairdo and striped blue and white shirt. Four weeks later you received an email that included a PDF attachment with a letter of intent that valued your company at 12 times this year’s EBIT. You took out your calculator, just in case you had forgotten your multiplication tables: 1€ million X 12 = 12 million euros. Each partner was going to receive a nice €4 million fat check at closing.  For negotiating sake, you rang up smiling Bob slick hairdo and told him you would take no less that a 15X multiple. Two days later you signed the letter of intent on the bidder’s terms and agreed to allow them to perform a in-depth due diligence.

Bob asked you if you were going to set up a data room, and after looking up in Google what it meant, you answered: “let’s keep this simple, just ask us what you want and we will share it on Google Docs”. Two months and a half after having opened up all your books to the potential buyer and having undressed fully including the first layer of skin, Bob let you know that the price had to be adjusted from €12 million to €8.4 million. “What? You must be joking? The PWC partner just told us that the due diligence had confirmed our audited accounts were consistent with their analysis. Why?”

Bob smiled: “yes, but we need to adjust your bottom line considering you are not paying yourself market salaries. You must understand our position. My client will take over the company and in one years’ time, when you leave, they will need to hire a new CEO, CFO and CTO. These roles will cost 300.000€ more than what you are currently paying yourself. We understand your logic for not paying yourself market salaries and simply distributing dividend, but you must understand you are overstating your profit. Your adjusted EBIT is actually 700.000€. Sorry”. Bob stopped smiling, and was actualy quite sorry when you let him know the deal was off and realized that he was not going to make his success fee, but that is another story.

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