In M&A, a business add-back involves identifying certain discretionary or non-recurring expenses and adding them back into the net income to create an accurate profit figure.
Common addbacks include one-time expenses, owner perks, and non-operational costs that are unlikely to persist post-acquisition (non-recurring).
This practice allows both buyers and sellers to assess the business’s value based on its sustainable, ongoing earnings potential, facilitating a more informed decision-making process in M&A transactions. However, it is also common for there to be some disagreement on add back amounts and what items should be added back.
What Expense Line Items Are Commonly Added Back?
The following expense line items are commonly added back to come up with an accurate adjusted EBITDA figure and therefore valuation:
- Personal automobile
- Leisure travel
- It’s common for business owners to mix personal vacations with client visits. Make sure to keep receipts so that we can support the discretionary expense portion of this trip.
- Payroll tax for personal salary
- Life insurance and other policies may also be added back
- Salaries for family members
- If you pay a family member that does NOT work in the business, this is an easy addback
Is Owner's Salary an Addback?
Yes and no. Let me explain…
If you have a small business (generally under $1m in discretionary earnings), the chances are that you are the operator of your company and that you will sell to another owner-operator. In this case, it is expected that they will step into your shoes and all of your earnings (salary included) will become their earnings. So in this case, Yes, salary can be added back.
If you have a lower middle-market business ($1m in earnings) the buyer will hire a CEO to fill in for you (assuming that you are the operator currently). In this case, we need to recast the income statement with a replacement salary to show what a new owner will need to pay a CEO to replace you.
The process of adding back your salary and simultaneously reducing cash flow by the cost of a new CEO is called normalizing.
Example, a new CEO will cost $200k, your current salary is $500k. In this case, a net $300k is added back in to create Adjusted EBITDA.
Are Add-backs Often Disputed?
While it is somewhat common for add-backs to be disputed, a good M&A advisor or business broker such as Raincatcher will set the expectation of what reasonable add-backs are to both the buyer and seller, AND, have support for those add-backs so that disputes are minimal.
Additionally, a good broker will address these items at the LOI stage before the deal is exclusive so that there is leverage to negotiate.