When it’s time to sell your business, it’s important that the financials presented to potential buyers are accurate. When valuing a business, buyers will place a multiple on the business’s earnings before interest, taxes, depreciation, and amortization (EBITDA).
If you have ongoing expenses that won’t be included in your cash flow after a transaction, these are called add backs. It’s essential to identify and factor in add backs when selling a business, as this will normalize the cash flows and increase the EBITDA, demonstrating to potential investors the true value of your business.
What Are Add Backs?
An add back is an expense that will not be included in the buyer’s future P&Ls for the company. Understanding and applying add backs and other kinds of adjustments helps normalize a business’s earnings on a go-forward basis. This will give all parties a true understanding of the cash flow, and therefore, the true value of the company.
What’s the Purpose of Add Backs When Selling a Business?
If you have a large number of add backs, this will increase the company’s earnings on a normalized basis. When a multiple is applied to those earnings, the overall value of the business will increase.
The goal of identifying add backs, however, is not to increase the value. The purpose of add backs is to show the correct historical financial statements to a potential buyer. This helps give potential buyers a clear view of the company’s future cash flows.
What Are the Different Kinds of Add Backs and Adjustments?
When analyzing your financials for potential add backs and adjustments, it’s helpful to understand what kind of expenses to consider. They include:
Positive Add Backs
- Owner Compensation: Sometimes owners take an excess compensation as compared to what a normalized CEO or president would see in the industry. The difference between the owner compensation and market compensation would create an adjustment to EBITDA.
- Benefits and Personal Expenses: These include benefits granted to owners or other employees that will not be granted on a go-forward basis. They may include memberships, as well as excess or non-operational travel and entertainment expenses.
- Market Value Adjustments: This adjustment can include rent or other expenses that may need to be normalized if they are over or under market value
- Inventory Adjustments: These can include adjustments for over- or under-capitalizing inventory, non-GAAP inventory procedures, as well as LIFO to FIFO adjustments.
Positive One-Time Adjustments
One-time adjustments are different than add backs in that they are not an ongoing historical expense, but were a one-time occurrence. These are expenses that were received in one year but may never occur again. They include items such as one-time professional fees, a lawsuit, disaster costs, or startup costs.
Add Backs: Factors to Consider
When accounting for add backs, you’ll want to analyze your P&Ls for the types of expenses and adjustments discussed above. Be careful not to miss one-time expenses that are easily overlooked.
When putting together your add backs, make sure each one is legitimate. If a potential buyer begins questioning the legitimacy of your add backs, this will throw all of your other financials and marketing documents into doubt, creating potential mistrust and damaging your integrity.
In addition to the various types of add backs and adjustments, different companies have different ones they must consider. An ESOP, for example, may have add backs that would differ from a family-owned business.
The team at MelCap Partners has expertise in factoring in add backs when selling a business. We know which add backs and adjustments are appropriate for your type of company. This helps get the process off on the right foot, creating real trust between the buyer and seller, and setting the correct initial value for your business right from the beginning.