When you’re ready to sell your construction business, ensuring you get the highest possible sale price is crucial. One of the key factors that can make or break the deal is how your earnings are presented. More specifically, this involves normalizing owner earnings—a critical step in making your business more attractive to potential buyers.
In simple terms, normalizing earnings means adjusting your business’s financial statements to reflect the true earning potential of the company, excluding any personal or non-recurring expenses related to the owner. By doing so, you can present a more accurate picture of the business’s profitability, which can lead to a higher sale price and a smoother transaction.
In this blog, we’ll dive into what normalizing owner earnings means, why it’s important, and how you can effectively normalize earnings before you sell your construction business.
1. What Are Owner Earnings?
Owner earnings refer to the total amount of profit a business generates after deducting all operational expenses, taxes, and capital expenditures. However, as a business owner, you may take personal or discretionary expenses that can skew the financial picture of the business. These may include:
- Owner’s salary and benefits: Compensation for the owner that might not be aligned with industry standards.
- Personal expenses: Any expenses paid through the business that are personal in nature, such as car payments, insurance premiums, or family-related costs.
- Non-recurring or one-time expenses: These might include legal fees, relocation costs, or other one-time expenses that do not reflect the ongoing operation of the business.
- Excessive perks or perks for family members: This can include any excess benefits not related to the day-to-day running of the business.
To truly understand the value of your construction business, it’s important for potential buyers to see your company’s profitability without these personal or non-recurring items.
Also read The Role of Customer Contracts in Boosting Your Business Valuation
2. Why Normalizing Owner Earnings Is Crucial Before Selling
Normalizing owner earnings is an essential process that helps both the buyer and seller understand the business’s true operating performance. Here’s why it matters:
1. Provides a Clear Picture of Profitability
Potential buyers want to know how much they can realistically earn from your business. By normalizing the earnings, you eliminate any distortions caused by personal or one-time expenses, giving buyers a clear understanding of the company’s ongoing profitability. This can help avoid any confusion or misinterpretation of your financial records, ensuring that buyers see the business as a valuable and profitable investment.
2. Increases the Business’s Value
When you normalize earnings, you make your business more attractive by presenting it as an efficient, profitable entity. Buyers are more likely to offer a higher price for a business that has consistent and reliable earnings. Without normalization, buyers may discount your earnings to account for the owner’s excess compensation or personal expenses, reducing the overall value of your business.
3. Reduces Buyer Risk
One of the biggest concerns for buyers is the potential risk of financial instability after purchasing the business. If they see abnormal earnings due to personal or non-recurring expenses, they may question whether the business is truly profitable. Normalizing these earnings gives the buyer more confidence, as it demonstrates that the business has sustainable earnings, independent of the owner’s personal financial decisions.
4. Helps Establish a More Accurate Multiple for Valuation
The value of most businesses, especially in the construction industry, is often determined based on a multiple of earnings (EBITDA, for example). When you normalize earnings, you create a more accurate basis for calculating this multiple. Buyers will be able to more clearly see the multiple that aligns with the actual earning potential of the business, allowing for a fairer, more transparent valuation.
3. How to Normalize Owner Earnings
Now that you understand why normalizing owner earnings is essential, let’s walk through the process of how to do it.
1. Remove Non-Recurring Expenses
Begin by identifying any one-time or non-recurring expenses that have been included in your financial statements. These might include costs for legal settlements, new equipment purchases, or other expenses that are not expected to continue in the future.
For example, if you incurred an unexpected legal fee during the year, remove that from the profit calculation. These types of expenses can artificially lower your earnings and confuse potential buyers about the business’s true financial health.
2. Adjust for Owner’s Salary and Benefits
As a business owner, you may pay yourself a salary that is above or below what would be considered a market rate for someone in your position. To normalize earnings, adjust your salary to reflect what a typical employee in that role would earn in the market.
For example, if your salary is higher than industry norms, reducing it to a reasonable figure will show that the business can generate more income for a potential buyer, without the inflated salary expenses. Similarly, if you’re underpaid, you might want to adjust your salary upwards to reflect market conditions.
3. Eliminate Personal Expenses Paid Through the Business
Another key area to address is personal expenses that have been paid through the business. If you’ve used the business for personal items, such as travel, utilities, or insurance, these costs should be removed from the earnings calculations.
For instance, if your business paid for your personal vacation or family health insurance, these expenses should be taken out of your earnings to give an accurate picture of the business’s profitability.
4. Account for Excessive Perks and Benefits
Many business owners use their company’s financials to cover personal perks, such as a company car, gym memberships, or private health benefits. These perks, although valuable, don’t contribute to the business’s ability to generate profit for a buyer.
Ensure that any personal perks are excluded from the business’s earnings to present a more accurate, business-specific picture of the company’s profitability.
5. Calculate Adjusted Earnings
Once you’ve made the necessary adjustments for non-recurring expenses, owner salary, personal perks, and any other discrepancies, calculate the adjusted earnings. These adjusted earnings, often referred to as normalized EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), will give potential buyers a clearer understanding of the ongoing earning potential of the business.
4. How Normalizing Earnings Affects the Sale Process
Normalizing your owner earnings helps both you and the buyer navigate the sale more smoothly. Here’s how:
1. Establishes a Stronger Asking Price
By normalizing earnings, you’ll have a stronger case for the asking price of your business. Buyers are more likely to justify a higher price when they see a clear, accurate financial picture. It allows you to defend your asking price with a solid explanation of how your earnings have been adjusted to reflect true business performance.
2. Increases Buyer Confidence
When buyers see that you’ve taken the time to present an accurate picture of the business, they’re more likely to trust your financials and proceed with the sale. This can help close deals faster and reduce the risk of buyer’s remorse after the sale.
3. Smoothens the Due Diligence Process
The due diligence process can be stressful and time-consuming, especially when buyers scrutinize financials. Normalizing earnings up front can help streamline this process by addressing potential red flags before they arise. Buyers won’t need to spend extra time deciphering unusual expenses or compensation; instead, they can focus on the business’s core financials.
5. Conclusion: Don’t Skip Normalizing Owner Earnings
When preparing to sell your construction business, normalizing owner earnings is a crucial step in ensuring you get the best possible price. By presenting adjusted earnings that reflect the true profitability of the business, you increase buyer confidence, reduce perceived risks, and improve the likelihood of closing a successful sale.
Take the time to work with a financial advisor or business broker to normalize your earnings properly. The effort you put in now can pay off significantly when it’s time to sell, leading to a smoother, more profitable exit from your business.
Also read How Deferred Maintenance Issues Affect the Sale of Your Business
Disclaimer:
Any information provided here is for informational purposes only. It should not be considered as legal, accounting, or tax advice. Prior to making any decisions, it’s the responsibility of the reader to consult their accountant and lawyer. N3 Business Advisors and its representatives disclaim any responsibilities for actions taken by the reader without appropriate professional consultation.
