I pay myself a below-market salary and take the rest of my compensation as distributions. During our upcoming QofE audit, how do we structure this adjustment to protect our adjusted EBITDA?

Question

Tyler Smith · Accepted Answer

During a Quality of Earnings audit, the buyer will analyze your historical operating expenses to calculate normalized EBITDA. If you pay yourself a below-market salary and take the rest of your compensation through distributions, your historical payroll expenses look artificially low. This makes your historical profitability look higher than it actually is. The buyer will try to adjust your EBITDA downward by replacing your low salary with a higher, market-rate salary for a replacement executive. To defend your valuation, you must proactively manage this adjustment. Do not let the buyer set an arbitrary market rate. Use industry salary benchmarks and your EOS Accountability Chart to define the exact market replacement cost for your seat. If your leadership team is already running the day-to-day operations and your seat can be replaced by promoting an internal director who is already on the payroll, use this structure to minimize the downward adjustment. Presenting a clear succession plan and documented roles during the QofE audit proves that the business does not need a highly-paid outside CEO. This preserves your adjusted EBITDA and keeps your valuation multiple intact.