Deducting the Owners Salary In Business Valuations
- Arnold Shields
- Oct 25, 2012
- 2 min read
Updated: Jun 2
One of the most common questions we get is: Why should the owner’s salary be deducted when valuing a business?
The Broker’s Perspective vs Reality
Business brokers often present a business’s value based on total earnings—that is, profit plus the owner’s salary. Why? Because they’re trying to sell the business and get the best price for the vendor.
But this approach is flawed when it comes to investment value. Just because it looks good on paper doesn’t mean it’s the right valuation methodology.
Investment vs Employment
When buying a business, you're not just buying a job—you’re making an investment. The correct approach is to assume that a manager will be employed to operate the business. That means the owner’s commercial salary must be accounted for as an expense.
The Numbers Don’t Lie
Let’s look at a simple example:
Profit after owner’s salary: $50,000
Owner’s commercial salary: $100,000
Broker’s “total earnings”: $150,000
Broker’s asking price (using a capitalisation rate of 3): $450,000
On the surface, this may look reasonable. But here’s the catch: the actual return on investment is just 11%, and that’s before considering capital repayments, taxes, or operational risks.
Now, let’s assume you borrow the $450,000 at 10% over 10 years. Your repayments would be approximately $73,250 per annum. But the business only generates $50,000 after paying the owner a fair salary. You’d be $23,250 worse off per year, not to mention the risk you’ve taken on.
The Risk-Return Trade-Off
Compare that to placing $450,000 in a term deposit at a Big 4 bank, earning a safe 5% per annum ($22,500). To justify investing in a riskier small business, you’d want a much higher return—at least 33% or more. That means a price of $150,000, not $450,000.
At that valuation:
Return on investment: $50,000 ÷ $150,000 = 33%
Loan repayments (10 years at 10%): $24,400
Net cash flow after debt: $25,600
That’s a much more sustainable and realistic investment.
The Harsh Truth: Most Small Businesses Have No Goodwill
In reality, most small businesses don’t generate enough profit to even justify the owner’s salary, let alone support a sale price that includes goodwill.
Basing business valuations on “total earnings” without deducting a fair salary leads to overpriced, underperforming investments.
Need help with a realistic business valuation?
At Dolman Bateman, we specialise in forensic and practical business valuations—grounded in real returns, not broker optimism.
Disclaimer:
The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.
