Understanding Add-Backs When Selling a Business

What is an Add-Back? Understanding Adjusted EBITDA

Use Add-Backs for a Business Valuation to Derive the Seller’s Discretionary Earnings SDE

What are Adjustments to Income or Normalized EBITA?

When selling your business, EBITDA add-backs help buyers understand the true profitability of your business more accurately. These add-backs are expenses that the current owners paid but will no longer exist under new ownership. They are expenses that are considered unusual, non-recurring, or discretionary.

Add-backs are part of your Seller’s Discretionary Earnings or SDE. Please read our article on what is SDE. The value of your business can increase if we can use your personal expenses in the addbacks and adjustments. The correct EBITDA adjustments with solid proof are critical to your successful exit strategy.

Add-backs or Adjustments to EBITDA as Part of the Business Valuation process

When evaluating a business valuation report, which is a dynamic process that helps assess the actual value of companies, the business valuation process will evaluate add-backs or discretionary expenses.

You will also hear the term normalized EBITDA or adjustments to income to describe the add-backs to the EBITDA process. Your EBITDA calculation should be easy to understand with solid proof.

Read our article what is a business valuation and how add-backs can help increase your company’s value or the value of your business. A business valuation with correctly adjusted EBITDA can help you hold the purchase price.

What Is EBITDA?

EBITDA, or earnings before interest, taxes, depreciation, and amortization, is an alternate profitability measure. It represents the cash profit generated by the company’s operations, as it excludes non-cash expenses, taxes, and debt costs dependent on the capital structure.

Because of the personal expenses in entrepreneur-owned businesses, it is important to calculate adjusted EBITDA taking add-backs into consideration.

What is an EBITDA Add-Back?

An add-back is an income or expense from a company’s profit and loss statement that a new owner could benefit from. Profits, owner’s salaries, and owner’s perks make up the total owner’s benefits of the business or the seller’s discretionary earnings SDE.

In addition to add-backs, there are adjustments in the other direction if an owner is underpaid or if there has been under-investment in Capex (capital expenditures).

Add-backs and adjustments aim to show buyers and sellers the business’s true earnings by adjusting EBITDA or earnings before interest, taxes, depreciation, and amortization. Cash flow is calculated as net income plus add-backs minus adjustments. An EBITDA multiple is only applicable when comparing similar businesses.

Gathering your add-backs and a business valuation is all part of your business exit plan as business owners. We will help you calculate the adjusted EBITDA formula.

Why would a company want to use business add-backs?

When selling your business, you want your potential buyer to have the most accurate and holistic picture possible of your true operating expenses, cash flows, and profits. Add-backs allow this to occur and often lead to an increase in the valuation of your business.

This will result in a better selling price and make the business more attractive to potential buyers. Add-backs can also provide better comparable analysis and more negotiation leverage, as the actual potential of earnings can allow you to negotiate for the best price.

Net earnings are important when it comes to accounting and taxation purposes for the IRS. However, when dealing with selling your business to a prospective buyer, net earnings most often do not show the full extent of the most accurate potential profits. This is almost always the case when selling a small business.

Understand what a business valuation should cost.

How do add-backs work in simple terms?

Say you have a staffing company, and you’ve been looking to sell your business. With some of the profits you’ve gained from the staffing agency, you’ve been taking trips to Hawaii. You expense these trips as travel and entertainment expenses.

This cost of vacation trips isn’t actually a cost of running your staffing agency, and so when you’re selling your firm, you want to “add back” the money you spent on the discretionary travel as profit. This will allow you to accurately show your potential buyer how much cash flow they can enjoy post-closing.

Also, see our detailed article on the different business valuation methods.

Can add-backs create a risk to the business seller?

When dealing with add-backs, having too many of them may create potential financial risk. It can be possible to overdo and inflate add-backs, misrepresenting the true profits of a business and creating distrust with your buyers.

Because of this, it is important to work with business valuation experts like Business Appraisal Florida. We will maximize your business value while minimizing risk by accurately representing your add-backs.

With a certified business valuation by Business Appraisal Florida, we will take our expert strategic and in-depth analysis to calculate EBITDA and review your potential add-backs with the utmost accuracy and transparency, creating the best-selling opportunities for you. 

What are some examples of legitimate types of common EBITDA add-backs?

• Owner’s Compensation

Successful business owners often allocate higher salaries or increased bonuses to themselves instead of ordinary yearly capital expenditures. While this may not pose a problem for the business, new owners can exclude these additional costs from the overall profit.

In some cases, the market demands that the business pay a higher owner compensation to a spouse or family members. In these situations, the business can also add back the difference in cost.

• One-time business expenses

One-time expenses are any expenses that a company has that only occur one time, such as remodeling or marketing promotions. You can add back these costs, as they are not regular costs. One-time professional fees like business valuations, CPA’s work on your exit strategy, litigation expenses, and business broker fees are legitimate one-time add-backs.

You can add back your cost of business valuation and your accounting expenses to your SDE, too.

• How the owner decides to spend and expense profits

The former owner of the company may have made various business expenses, including a company car, sponsorships, life insurance, entertainment, and other expenses that a new owner may not consider essential.

Also, read our article about what is my business worth and how you can increase your business value.

• Differences in compensation

Sometimes, the company may hire a family member and pay them a higher salary than usual. If the company replaces them, they can hire someone for less pay, increasing profit and considered an add-back.

• Interest expenses from loans

The decision to apply for a loan is up to the business owner. Consider late payment interest as an add-back. Add back interest, taxes, and depreciation. If the sale does not include real estate, add back only the interest, not the principal payment.

• Severance and lawsuit settlements

The company can treat this as an expense that reduces net earnings since such payments are uncommon for the company. Non-recurring bad debt can also be an add-back.

• Personal expenses

Personal expenses include non-business-related purchases made by the owner using business profits, which are coded to an SG&A account. Expenses of this nature can be considered add-backs. 

• Unexpected weather-related damage

Natural events like storms, fires, and earthquakes can be considered add-backs since they are unlikely to occur regularly. COVID is an example.

Read our short guide on choosing a business valuation company.

What are examples of non-legitimate types of add-backs?

Income statements should not list recurring expenses as “one-time expenses”, and we cannot automatically consider them as add-back expenses. The same rule applies to potential add-backs after a business acquisition – we cannot include them in the EBITDA calculation during a sale.

Also read: obtain a company valuation before you sell your business to get the best EBITDA multiple.

Why are capital expenditures (Capex) not on the Income Statement?

Capital expenditures (Capex) are not reflected on the income statement primarily because they represent long-term investments in a company’s assets rather than immediate expenses. When a company acquires or improves an asset—such as machinery, buildings, or technology—it incurs a substantial outlay. These costs are expected to benefit the company over several years, making it more appropriate to categorize them as assets on the balance sheet.

In contrast, the income statement focuses on a company’s performance over a specific period, detailing revenues and expenses directly tied to that timeframe. While Capex is not directly listed on this statement, its impact is felt indirectly through depreciation and amortization. Over time, portions of these capital expenditures are expensed on the income statement as depreciation, reflecting the gradual wear and tear or use of the company’s invested assets.

How can one support considering an expense as an add-back?

Several factors should be taken into account when arguing that an expense should be considered an add-back to ensure its legitimacy.

• Identify and show the actual amount on the tax return or financial statement source document.
• Business owners find add-backs on the profit and loss or income statements rather than the balance sheet. Disbursements come out of profits that have already been “booked.” If an expense wasn’t a P&L line item, it cannot be “added back.”
• Collaborate with your CPA to generate a General Ledger Report containing the expenses for the add-back being used.
• Explain why this cost will not be incurred for the new business owner.
• Accrual accounting may show your business in a better light than cash-based accounting. Look at your financials to get the best picture of your business.

M&A Advisory Firms and Private Equity

Are you using an M & A advisory firm? We take the EBITDA adjustments and do business valuations for private equity, SBA lenders, and M&A advisory firms.

Please read how much I should sell my company for.

As a business owner, do you need help with your business valuation steps, or what makes up a business valuation? Please call or contact BA FL|GA|HI.