Photo by Mikhail Nilov
An “add-back” is an expense credited to a business’s reported profit to show a more accurate picture of what a buyer could earn. These are often personal or discretionary, non-recurring expenses that a current owner incurred, which wouldn’t be required of a new owner. Classic examples include:
- One-time legal fees
- Personal travel
- Payroll to non-working family members
By identifying and adding back these expenses, the business’s EBITDA becomes more standardized and “realistic.”
Sellers are going to look for add-backs to boost valuation. Buyers are going to scrutinize those addbacks to make sure they are legitimate expenses that will not be carried forward.
What is frustrating to us as advisors and is often devastating to the sellers is when they see that playing cute with the IRS has actually cost them a LOT of money.
In a recent podcast episode Andy did two calculations for a business with some of these egregious add-backs (e.g. “the business” was paying a home mortgage). In the first scenario, with all the unjustifiable add-backs, the sellers saved $47,000 in taxes. In the second scenario, with all these expenses removed and the business allowed to run clean, it netted an extra $584,000 in valuation. Pretty stark, no?
Some of the other more ridiculous ones we’ve seen over the years include:
- A spouse’s breast augmentation strategy classified as “building improvements”
- All family groceries paid by the business
- Private school tuition
- Lake house used as company retreat
Buyers Get Spooked
So much of a business transaction is building trust, and no buyer gets really excited about seeing a lot of add-backs, especially knowing that they will have to comb through them in due diligence. What we often see here is potential buyers passing by when they see a lot of add-backs.
Sellers Can Cure This
We always say that we want to see you some years before you are ready to sell. That allows us to set goals for what we want to sell the business for and then put plans in place to achieve that price. Part of those plans will involve flushing out unreasonable add-backs so as to create cleaner books and a more believable narrative of a trustworthy business looking for a solid buyer.
Did some of what we said in this article sound a little too familiar? No shame or judgment here. We just want to help you get this fixed up so that you can get maximum value for your business and a seller can see straight through to the actual expenses of the business instead of sorting through the weeds of shady add backs. Reach out today and we will help you get cleaned up.