Addbacks – adding a past expense back to a company’s profits to show its true earnings potential – will be part of almost every business sale, so it’s important for owners to understand them. Many sellers are either not quite sure what an addback is, or think they know but miss the mark.
Here are three addback misconceptions that come up often:
Almost all my business expenses are addbacks. I run into owners who pursue an aggressive tax-avoidance strategy in their business. They write off almost everything they spend to run the company to pay as little income tax as possible. The problem with this approach is that their profit, on paper, is very low. When they’re negotiating a sale, the buyer’s offer – and the multiple – will be based on that profit number. That means they lose out on the a significant amount of profit from the sale.
I always advise owners who are thinking about retiring or selling to take the time to clean up their books so the SDE (Seller’s Discretionary Earnings) are clear and easily provable. Start early (a year or two before selling), taking out the addbacks that are an advantage to you but a red flag for buyers. The math should be simple: you can save 30 cents in taxes on every dollar you spend, or you can make 3-4X every dollar of profit you’ve made when you sell.
Things I choose to do as an owner are always addbacks. From staff bonuses to Little League sponsorships, many owners view optional expenses as addbacks. It’s true that the definition of an addback is something the new owner doesn’t need to run the business. But your sponsorships might be bringing in a significant amount of new or returning business, making them valuable marketing investments. The bonuses you’ve given to high-performing employees may be an important part of your retention rate. A new owner will probably have to match them to keep the best talent on after the sale.
Here’s a good rule of thumb: if the expense is benefiting you personally more than the business, it’s probably an addback. One way to clean up your books before a sale is to normalize salaries and other expenses. If you’re paying your spouse $50,000 a year for part-time bookkeeping, the difference between their salary and what it would take to hire a new part-time bookkeeper is the addback. If you’re paying yourself rent on the facility at twice the market rate, the normalized difference is the addback. The new owner will have to rent space, but they won’t have to pay the same rate you’re willing to pay yourself.
I should have the buyer’s team look up and determine which addbacks are. I always advise sellers to do the work for the buyers. Producing 60 pages of credit card statements that are ambiguous (how much of that Home Depot purchase was for the business and how much of it was personal?) means the buyer has to verify every single line item. It annoys them and makes them wonder why you’re making their job harder. They start to look for other things you might be concealing in the books, and their trust in you erodes.
Instead, you should present your addbacks clearly and cleanly up front. One-time expenses (with justification), personal expenses that will not be carried forward, and non-recurring items, such as technology upgrades, all qualify as legitimate and provable addbacks. Don’t make your financials into a game of Hide and Seek. Every deal requires trust, and transparency about your actual profitability means closing will be quicker, cleaner, and less contentious.
If I can help you understand what your company is worth in today’s market, contact me for a free and confidential valuation.
