A buyer who will not run the business has to pay someone who will. That fact separates the second bridge from the first, and this span puts it into numbers. The owner is still in every seat they held before and nobody has been hired, but the earnings are restated as though each of those seats were filled at the market rate, because a buyer's model will do exactly that as soon as it opens the file.
What the measure is
The measure here is pro forma EBITDA: normalized SDE less a costed, market-rate replacement for the owner, who is still doing the work. Pro forma means as if. The figure is what the business would earn if employees paid at market did the owner's work, calculated before any of those employees exist.
It comes second on the bridge because it is computed from normalized SDE, and before reported EBITDA because the costs it deducts on paper are the ones the next span turns into payroll. It is also the first measure in the framework that treats the owner as a cost, where every earlier measure treated them as the person the earnings belong to, and the whole bridge is built around that change.
After every owner seat is paid for
Illustrative. Pro forma EBITDA is normalized SDE less the fully loaded market cost of every seat the owner fills, including the one the owner keeps. A buyer's model will make this deduction whether or not the seller does.
The illustration shows the usual surprise. A business with $420,000 of normalized SDE, whose owner fills the general management, sales and estimating seats, would pay $310,000 a year at market for those three seats once each is fully loaded. Its pro forma EBITDA is $110,000, a margin of under 5 percent on $2.4 million of revenue. The owner had thought of it as a business that makes over $400,000 a year. A buyer who will not run it sees one that makes a little over a quarter of that.
The two drivers
What moves normalized SDE to pro forma EBITDA
Two drivers do the work: one prices the owner's seats, the other makes them jobs someone else could do.
Normalized SDE
- Role CostingNames every seat the owner fills and deducts a benchmarked, fully loaded market cost for each
- Procedure CaptureTurns each owner seat into a job a market-rate hire could do, with the owner's remaining decisions on a short list
Pro forma EBITDA
Role Costing finds the owner's seats and prices them. Four weeks of the owner's time, logged by function, decide which seats carry the owner's name. The organization chart is drawn seat first, with empty seats left showing. Each owner seat is priced from at least two sources and loaded for payroll taxes, benefits and the expected bonus, and a month-by-month pro forma and staffing plan show when each hire comes and how it will be paid for.
Procedure Capture makes each of those seats something a hire can do. A writer shadows the owner through each function and records it on a common template. The decisions that still reach the owner are logged and given thresholds. And each procedure is run once by the person who will own it, with the owner watching in silence, before the owner steps away on the next span.
Why both are needed
Role Costing produces the number, and Procedure Capture makes it true.
A pro forma that deducts a market salary for the general manager's seat assumes that a general manager at that salary could do the job. If the job exists only in the owner's head, the assumption is false. The hire routes every decision back to the owner, the owner stays in the seat, and the business pays both. A buyer sees nothing the salary bought, and responds by deducting a higher salary for a more senior hire or by pricing in the risk that the hire fails.
A seat with a written procedure, a short list of decisions the owner still makes, and evidence that someone else has run the procedure end to end is a seat the market rate can fill. That is why Procedure Capture ranks near the top of this bridge's work on value. It lowers the probability that the owner's successor fails, one of the two largest risks a buyer at this anchor prices, and it costs a writer's time.
Role Costing ranks last on value, because all it does is lower the honest earnings figure, and a correction is not a gain. It is still done early, so that a business that cannot survive the deduction finds out before it starts hiring.
A number the business can bear
The exit condition is plain: a buyer can deduct a manager's salary in the model and still like the result. Pro forma EBITDA after every replacement cost has to be positive, and the staffing plan has to show the cash to fund the hires before they pay for themselves.
That condition tests the business itself. Some businesses meet it easily, because the owner holds few seats and the margins are healthy. Others find here that their earnings were mostly the owner's own unpaid or underpaid labour, and that once the work is priced at market there is little left for a buyer who will not do it. The discovery is uncomfortable and useful. Such a business has two honest options. It can improve the economics, through price, cost or growth, until the pro forma can carry the seats. Or it can accept that its natural buyer is an owner-operator and that the first bridge was the right place to stop.
Paying for the crossing
The pro forma describes a future that has to be paid for before it arrives. A new general manager costs a full salary from the first day and frees little of the owner's time for months while learning the business. A sales lead needs a selling cycle or two before the pipeline produces revenue. For a while the business carries the new payroll and an owner still doing much of the work, and its cash flow falls before it recovers.
So the staffing plan is built month by month from the normalized statements and has to show the cash for the hires before they pay for themselves. A business with a strong season can afford to hire ahead of its busy months, and cannot afford to hire after them. One with a thin reserve may have to hire a seat at a time, starting with the one that frees the most of the owner's time per dollar. The order of the hires is part of the plan, and so is the seat the owner keeps, which is named in advance and costed at market like the rest.
A buyer will not credit a pro forma that is positive in the long run and unaffordable in the next six months. A business that has worked out how to pay for the crossing, and has the reserve or the facility to do it, has shown that its pro forma is somewhere it can actually get to.
How the span comes undone
The owner drifts back into the seats they meant to leave: a hire struggles, the owner steps in to help, and within a quarter the owner is doing the job again. Or a manager leaves, and the owner absorbs the work instead of hiring again.
The safeguards, which the two driver essays set out, share one idea, which is to make the drift visible before it reaches the earnings. A week of time logging each quarter shows an owner creeping back into a seat. Benchmarks refreshed every year mean a vacated seat can be refilled at a known cost. Review dates on procedures, and a quarterly review of an escalation list whose thresholds only move up, mean a decision that has left the owner's desk returns only if someone decides it should.
Crossing the span
The span is crossed when the owner's seats have been named from a time log and each priced at a sourced, fully loaded market cost; when the pro forma after those costs is positive and the cash to fund the hires is shown; when every function has a procedure someone else has run; and when the decisions the owner still makes sit on a short list with a threshold against each. The next span hires the people the pro forma assumed.