Add-backs: counting the money the business really makes for you

The short version

• Add-backs are expenses on your books that a new owner would not have. Adding them back shows what the business really earns.
• Common add-backs include your own pay, personal expenses run through the business and one-time costs.
• Every add-back needs a record behind it. Buyers and lenders challenge the ones that do not.
• Add-backs work both ways. If a new owner would have to spend more than you do, earnings come down.
• Every dollar of add-back is multiplied in the price. So is every dollar a buyer rejects.

What an add-back is

Your tax return shows profit after every expense the business paid. Some of those expenses exist only because you own the business. A new owner would not pay them.

Adding those expenses back to profit shows what the business earns for an owner. That adjusted figure is what buyers multiply to set a price. Lesson 3.3 explains SDE and EBITDA, the two ways it is measured.

Common add-backs

• Your own salary and benefits, for SDE. For EBITDA, only the amount above a fair manager's salary.
• Personal expenses run through the business: a personal vehicle, a family phone plan, travel that was not for business.
• Family members on payroll who do not work in the business.
• One-time costs that will not repeat: a lawsuit, a major repair after a storm, a one-time consulting project.
• Interest, depreciation and amortization.
• Rent above market paid to yourself, if you own the building. Lesson 4.7 covers this.

What does not count

• Unreported income. Lenders confirm your tax returns with the IRS. Cash that was never reported cannot be added back.
• Costs the business actually needs. Calling a necessary expense "discretionary" does not make it so.
• "One-time" costs that happen every year. If the major repair comes around every year, a buyer will treat it as a normal expense.

Add-backs can go the other way

Buyers also look for costs a new owner would have that you do not. These reduce earnings.

• Pay below market. A family member paid far below market, or a key employee who has not had a raise in years.
• Rent below market paid to yourself.
• Deferred maintenance. Equipment that needs replacing soon.
• Work you do for free that a new owner would have to pay someone to do.

The paper trail

For each add-back, keep the record that proves it: the receipt, the invoice, the payroll record or a short written explanation. Put the list and the support in your data room.

A buyer's accountant will test every item. Add-backs with records usually hold. Add-backs without them are the first to go.

Why it matters so much

Add-backs are multiplied. If buyers pay three times earnings, every $10,000 of add-back that holds adds about $30,000 to the price. Every $10,000 a buyer rejects takes $30,000 away.

That is why a long list of weak add-backs does more harm than good. It invites a buyer to question everything else.