What Are Add-Backs When Valuing a Business?
I see this all the time when reviewing a business owner's financials.
"That's an add-back."
Sometimes it is.
Sometimes it isn't.
Add-backs can make a significant difference when determining the true earnings of a business. But just because an owner considers something an add-back doesn't necessarily mean a buyer, lender, or advisor will agree.
The easiest question to ask is:
Would the next owner still have to pay for it?
If the answer is yes, it's probably a real business expense.
If it's truly personal, one-time, or something that goes away when the owner leaves, that's a different conversation.
What Is an Add-Back?
An add-back is generally an expense that appears on the company's financial statements but isn't expected to continue under new ownership.
Depending on the business, examples might include an owner's personal expenses paid through the company, certain owner compensation, or a legitimate one-time expense.
These adjustments are commonly used when calculating Seller's Discretionary Earnings (SDE) or adjusted EBITDA to get a better picture of the earnings available to a new owner.
But there's an important distinction.
An expense doesn't become an add-back simply because the current owner says it is.
Would the Next Owner Have to Pay for It?
This is one of the first questions I ask.
If the next owner will need to continue paying the expense to operate the business, it's probably not an add-back.
For example, eliminating an owner's salary may look like an add-back on paper. But if a buyer needs to hire someone to perform that owner's job, the cost of replacing that role needs to be considered.
The same applies to employees, vehicles, professional services, marketing expenses, and other costs necessary to operate the business.
The goal isn't to create the highest possible adjusted earnings number.
It's to understand what the business actually earns.
Can You Prove Your Add-Backs?
There's another question that's just as important:
Can you document it?
It's one thing to say your business has $100,000 in add-backs.
It's another to be able to identify those expenses on the financial statements and explain why each one won't continue under new ownership.
Buyers and lenders are going to look closely at these adjustments.
Good documentation makes that conversation much easier.
Review Your P&L Before You Need To
Pull out your most recent profit and loss statement and look at the expenses you consider add-backs.
For each one, ask yourself two questions:
Would a buyer agree with me?
Could I prove it?
If you can't confidently answer yes to both, it's worth taking a closer look.
Understanding your legitimate add-backs can make a meaningful difference when determining Seller's Discretionary Earnings, adjusted EBITDA, and ultimately what your business may be worth.