The Three Ways to Negotiate
Basically, there are three major negotiation methods.
1. Take it or leave it. A buyer makes an offer or a seller makes a counter-offer – both sides can let the “chips fall where they may.”
2. Split the difference. The buyer and seller, one or the other, or both, decide to split the difference between what the buyer is willing to offer and what the seller is willing to accept. A real oversimplification, but often used.
3. This for that. Both buyer and seller have to find out what is important to each. So many of these important areas are non-monetary and involve personal things such as allowing the owner’s son to continue employment with the firm. The buyer may want to move the business.
There is an old adage that advises, “Never negotiate your own deal!”
The first thing both sides have to decide on is who will represent them. Will they have their attorney, their intermediary or will they go it alone? Intermediaries are a good choice for a seller. They have done it before, are good advocates for their side and they understand the company and the seller.
How do the parties get together in a win-win negotiation? The first step is for both sides to work with their advisors to settle on the price and deal structure positions. Both sides should be able to present their side of these issues. Which is more important – price or terms, or non-monetary items?
Information is vital to a buyer. Buyers should keep in mind that the seller knows more about the business than he or she does. Both buyer and seller need to anticipate what is important to the other and keep that in mind when discussing the deal. Buyer and seller should do due diligence on each other. Both buyer and seller must be able to walk away from a deal that is just not going to work.
Bob Woolf, the famous sports agent said in his book, Friendly Persuasion: My Life as a Negotiator, “I never think of negotiating against anyone. I work with people to come to an agreement. Deals are put together.”
Copyright: Business Brokerage Press, Inc.
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Keys to a Successful Closing
The closing is the formal transfer of a business. It usually also represents the successful culmination of many months of hard work, extensive negotiations, lots of give and take, and ultimately a satisfactory meeting of the minds. The document governing the closing is the Purchase and Sale Agreement. It generally covers the following:
• A description of the transaction – Is it a stock or asset sale?
• Terms of the agreement – This covers the price and terms and how it is to be paid. It should also include the status of any management that will remain with the business.
• Representations and Warranties – These are usually negotiated after the Letter of Intent is agreed upon. Both buyer and seller want protection from any misrepresentations. The warranties provide assurances that everything is as represented.
• Conditions and Covenants – These include non-competes and agreements to do or not to do certain things.
There are four key steps that must be undertaken before the sale of a business can close:
1. The seller must show satisfactory evidence that he or she has the legal right to act on behalf of the selling company and the legal authority to sell the business.
2. The buyer’s representatives must have completed the due diligence process, and claims and representations made by the seller must have been substantiated.
3. The necessary financing must have been secured, and the proper paperwork and appropriate liens must be in place so funds can be released.
4. All representations and warranties must be in place, with remedies made available to the buyer in case of seller’s breech.
There are two major elements of the closing that take place simultaneously:
• Corporate Closing: The actual transfer of the corporate stock or assets based on the provisions of the Purchase and Sale Agreement. Stockholder approvals are in, litigation and environmental issues satisfied, representations and warranties signed, leases transferred, employee and board member resignations, etc. completed, and necessary covenants and conditions performed. In other words, all of the paperwork outlined in the Purchase and Sale Agreement has been completed.
• Financial Closing: The paperwork and legal documentation necessary to provide funding has been executed. Once all of the conditions of funding have been met, titles and assets are transferred to the purchaser, and the funds delivered to the seller.
It is best if a pre-closing is held a week or so prior to the actual closing. Documents can be reviewed and agreed upon, loose ends tied up, and any open matters closed. By doing a pre-closing, the actual closing becomes a mere formality, rather than requiring more negotiation and discussion.
The closing is not a time to cut costs – or corners. Since mistakes can be very expensive, both sides require expert advice. Hopefully, both sides are in complete agreement and any disagreements were resolved at the pre-closing meeting. A closing should be a time for celebration!
The Confidentiality Myth
When it comes time to sell the company, a seller’s prime concern is one of confidentiality. Owners are afraid that “if the word gets out” they will lose employees, customers and suppliers. Not to downplay confidentiality, but these incidents seldom happen if the process is properly managed. There is always the chance that a “leak” will occur, but when handled correctly, serious damage is unlikely. Nevertheless, a seller should still be very careful about maintaining confidentiality since avoiding problems is always better than dealing with them. Here are some suggestions:
- Understand that there is a “Catch 22” involved. The seller wants the highest price and the best deal, and this usually means contacting numerous potential buyers. Obviously, the more prospective buyers that are contacted, the greater the opportunity for a breach of confidentiality to occur. Business intermediaries understand that buyers have to be contacted, but they also realize the importance of confidentiality and have the procedures in place to reduce the risk of a breach. Another alternative is to work with just a few buyers. This, however, does reduce the chances of obtaining the best price.
- Another way to avoid this breach is to try to keep a short timetable between going to market and a closing. The shorter the timetable, the less the chance for the word to get out. One way to keep a short timetable is to gather all of the information necessary for the buyer’s due diligence ahead of time. Create a place where all of this material can be consolidated. This can be as simple as a set of secured file drawers. Such documentation as: customer and vendor contracts, leases and real estate records, financial statements and supporting schedules (assets, receivables, payables), conditions of employment agreements, organization charts and pay schedules, summary of benefit programs, patents, etc. should be gathered. It is not unusual for due diligence examinations to look back 3 to 5 years, so there could be a lot of records.
- The above means that the seller has to get organized. Selling one’s business is fraught with paperwork. Set up some three-ring binders so all of the relevant paperwork and resulting documentation has a place. These binders should be kept in a secure location.
- The seller’s employees should be conditioned to having strange people (potential buyers) walk through the facility. One way to avoid suspicion is to arrange to have unrelated people, for example – customers, suppliers, advisors – tour the company facilities prior to placing the business on the market.
- If sellers have not prepared their employees for strangers walking through the facilities as suggested above, awkward situations can develop. A valued employee may question why tours are being conducted. The seller is then placed in the position of explaining what is happening or covering the question with a “smokescreen.” A seller could reply by saying that the strangers are possible investors in the company. If asked directly if the business is for sale, the seller could respond by saying that if General Electric wants to pay a bundle for it – anything is for sale. Once in the selling process, it is also important to minimize traffic by only allowing serious, qualified prospects to tour the operation.
- Keep in mind that confidentiality leaks can emanate from many sources. For example, an errant email ends up on someone else’s email. A fax gets sent to the wrong fax machine or UPS or FedEx deliveries go to the wrong people. Establish methods ahead of time on how to communicate with potential buyers or an intermediary.
- The key to handling confidentiality is for the seller to retain a third party intermediary. They will insist that all potential buyers sign a confidentiality agreement. They will also be able to advise the seller on how to handle the “company tours” and can insure that only qualified buyers are shown the facilities.
- The “myth” is that confidentiality issues can make or break a deal, or cause serious damage to the seller’s business. The reality is that breaches seldom occur when an intermediary is involved, and if they do occur and are handled properly, there is little damage to the business or a potential transaction.
Copyright: Business Brokerage Press, Inc.
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How Does Your Business Compare?
When considering the value of your company, there are basic value drivers. While it is difficult to place a specific value on them, one can take a look and make a “ballpark” judgment on each. How does your company look?
| Value Driver | Low | Medium | High |
|---|---|---|---|
| Business Type | Little Demand | Some Demand | High Demand |
| Business Growth | Low | Steady | High & Steady |
| Market Share | Small | Steady Growth | Large & Growing |
| Profits | Unsteady | Consistent | Good & Steady |
| Management | Under Staffed | Okay | Above Average |
| Financials | Compiled | Reviewed | Audited |
| Customer Base | Not Steady | Fairly Steady | Wide & Growing |
| Litigation | Some | Occasionally | None in Years |
| Sales | No Growth | Some Growth | Good Growth |
| Industry Trend | Okay | Some Growth | Good Growth |
The possible value drivers are almost endless, but a close look at the ones above should give you some idea of where your business stands. Don’t just compare against businesses in general, but specifically consider the competition.
As part of your overall exit strategy, what can you do to improve your company?
© Copyright 2015 Business Brokerage Press, Inc.
Photo Credit: kconnors via morgueFile
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What Are Add-Backs When Selling a Business?
By Troy Frank, Owner — Indiana Equity Brokers
Estimated read time: 8 min
The short answer: Add-backs when selling a business are expenses on your P&L that a buyer would not incur after buying your business, so they get added back to the profit figure to show what the business actually earns. Common examples include one-time legal costs, the owner’s salary at an above-market rate, personal expenses run through the company, and non-recurring items like equipment replacement. On a business valued at 2.5x seller’s discretionary earnings, a $100,000 in legitimate add-backs increases your sale price by $250,000. The catch is that buyers and SBA lenders scrutinize every add-back, and sellers who push the boundaries don’t just lose credibility on one line item — they lose credibility across the entire deal.
Every business owner running a profitable company has probably noticed a tension at tax time. The goal is to show as little profit as possible. But when it comes time to sell, the opposite is true: buyers and lenders want to see strong earnings, and the sale price is directly tied to what those earnings look like on paper.
This is where add-backs come in, and where sellers can either present their business accurately and get paid what it’s worth, or oversell it and watch a deal fall apart.
What Normalizing Your P&L Actually Means
When a broker or accountant talks about “recasting” or “normalizing” your financial statements, they’re describing a process of adjusting your reported earnings to reflect what the business would earn under typical ownership. Your tax returns are built to minimize taxable income. A normalized P&L is built to show a buyer the real earnings picture.
The difference matters because buyers value small businesses as a multiple of those earnings. For most Main Street businesses in Indiana, that multiple is somewhere between 2 and 3 times seller’s discretionary earnings (SDE). So if your tax returns show $200,000 in profit but your normalized P&L shows $350,000 after legitimate add-backs, you’re not just changing a number on a spreadsheet. You’re changing your sale price by $300,000 to $450,000, depending on where the multiple lands.
Seller’s discretionary earnings is the number brokers and buyers actually use. It starts with the business’s net income and then adds back the owner’s total compensation (salary, benefits, and any perks), depreciation, interest on business debt, and anything else that a new owner wouldn’t need to spend. That last category is where the add-backs conversation gets interesting.
What Counts as a Legitimate Add-Back
Not every expense on your P&L qualifies as an add-back, and the line between legitimate and questionable matters a great deal in how buyers respond to your financials. The ones that tend to hold up well are expenses that are genuinely one-time, genuinely personal, or genuinely above market.
One-time expenses are the most straightforward. If you spent $60,000 on legal fees defending a lawsuit that’s now settled, a buyer isn’t going to spend that $60,000 again. Adding it back to your earnings is defensible because it won’t recur. The same logic applies to a one-time equipment replacement, a major facility repair, or costs related to a business disruption that’s been resolved.
Personal expenses run through the company are also common and generally acceptable, as long as they’re reasonable in size. Things like a vehicle that’s used partly for personal purposes, health insurance for the owner and their family, or a cell phone plan that covers the owner’s personal line are all fair game. The key word is “reasonable” — buyers accept these because they’d simply stop paying them after acquisition.
Owner compensation is where the most significant add-backs often happen. If you’re paying yourself $300,000 a year and a replacement manager would cost $120,000, the difference is an add-back. The $180,000 gap represents compensation above what the business actually needs to operate. But if your $300,000 salary is what the market would pay for someone doing your job, adding it back entirely isn’t going to fly.
The Math: How Add-Backs Affect Your Sale Price
Here’s a concrete example to show why this matters so much. Say your business shows $200,000 in net income on your tax returns, but after a careful review you’ve identified $150,000 in legitimate add-backs: $80,000 in above-market owner compensation, $30,000 in personal expenses run through the business, $25,000 in one-time legal fees, and $15,000 in depreciation. Your normalized SDE is now $350,000.
At a 2.5x multiple, which is common for a Main Street business in Indiana with solid earnings and reasonable growth, $200,000 in SDE gets you a $500,000 asking price. But $350,000 in SDE gets you $875,000. That $150,000 in add-backs, properly documented and defensible, changed your sale price by $375,000.
That’s the reason sellers care about this process. It’s also the reason buyers scrutinize it. Both parties understand exactly what’s at stake, and buyers have advisors, accountants, and SBA lenders all reviewing the same numbers.
Where Sellers Cross the Line
The warning signs that buyers and SBA lenders watch for aren’t subtle. When add-backs are excessive or poorly documented, they don’t just lose credibility on their own — they make buyers question the entire financial picture.
Recurring expenses presented as one-time are the most common problem. Every year, some business owner replaces a piece of equipment, deals with a legal matter, or faces an unexpected cost. The original BBP guidance on this point is right: there really is no such thing as a completely one-time expense, because something unexpected comes up every year. Buyers know this. Adding back every unexpected cost, year after year, turns a one-time adjustment into an operating expense in disguise.
Expenses that can’t be verified are also a problem. If you’re claiming $40,000 in cash compensation that doesn’t appear on any tax form, a buyer can’t confirm it, an SBA lender won’t accept it, and an appraiser won’t include it. Add-backs need paper trails — bank statements, receipts, canceled checks, payroll records.
The subtler risk is volume. A small number of well-documented add-backs with clear explanations is a normal part of any business sale. A long list of add-backs that together represent a huge percentage of reported income raises a different kind of question: if this business generates this much in “real” earnings, why do the tax returns look so different? Buyers start wondering what else they don’t know.
SBA lenders apply their own lens here. They’re approving loans based on the business’s ability to service the debt after acquisition, and they’ll scrub the add-backs themselves. If their analysis produces a lower SDE than the seller’s, the approved loan amount drops accordingly. That can blow up a deal even when the buyer and seller have already agreed on price.
Who Should Prepare Your Normalized P&L
This isn’t something to put together yourself in a spreadsheet the week before you list. A properly prepared normalized P&L is typically drafted by a CPA or broker working together, and it needs to be ready before the business goes to market.
The reason is timing. When a buyer sees your listing and requests financial information, the first thing they’re looking at is three years of tax returns alongside a recast P&L. If those numbers don’t reconcile cleanly, with clear explanations for every adjustment, you’ve created doubt before you’ve even had a conversation. Doubt at that stage is hard to recover from.
Indiana Equity Brokers builds out a normalized P&L as part of our listing process, which is one of the reasons we encourage sellers to come to us before they’ve contacted buyers or shared financials informally. Getting the numbers right from the start protects you through the whole sale process.
Frequently Asked Questions
What are add-backs when selling a business? Add-backs are adjustments to a business’s profit and loss statement that increase the reported earnings to reflect what the business would earn under new ownership. They include expenses the owner personally incurred (vehicle use, health insurance, above-market compensation), one-time non-recurring costs (legal fees from resolved litigation, major one-time repairs), and accounting entries like depreciation that don’t affect cash flow. Each add-back requires documentation and a clear explanation for buyers and lenders to accept it.
How do add-backs affect the sale price of a business? For most Main Street businesses, the sale price is a multiple of seller’s discretionary earnings, so add-backs directly increase the price. At a 2.5x SDE multiple, every $100,000 in legitimate add-backs adds $250,000 to the sale price. The key word is “legitimate” — buyers and SBA lenders scrutinize add-backs carefully, and aggressive or poorly documented adjustments are often rejected or cause buyers to lower their offers to account for the uncertainty.
What add-backs do SBA lenders accept? SBA lenders generally accept add-backs that are documented, non-recurring, and wouldn’t be incurred by a new owner operating the business at market rates. Owner compensation above a market replacement salary, verified personal expenses run through the business, and documented one-time costs are typically accepted. SBA lenders conduct their own analysis of the financials and will adjust the add-backs they accept based on their review, which affects the loan amount they’re willing to approve.
What add-backs do buyers push back on? Buyers scrutinize add-backs that are large in total, recurring in nature despite being labeled one-time, unverified (especially cash transactions not reflected in tax documents), or expenses that seem normal for any business to incur. They also push back when add-backs together represent an implausibly large percentage of the reported profit, since that raises broader questions about the reliability of the financial records.
Do I need an accountant to normalize my P&L before selling? Working with a CPA or an experienced broker to prepare the normalized P&L is the right approach for most sellers. A recast statement prepared by a professional carries more weight with buyers and lenders than a seller’s own spreadsheet, and it’s less likely to include adjustments that won’t hold up to scrutiny. It should be ready before you go to market, not assembled during due diligence.
Get the Numbers Right Before You Go to Market
The sellers who get the most out of this process aren’t the ones who add back the most — they’re the ones who add back what’s legitimate and can document every line. A clean, defensible recast P&L builds buyer confidence instead of eroding it, and buyer confidence at the financial stage is what keeps a deal from renegotiating after due diligence.
If you’re thinking about selling your Indiana business and want to understand what your normalized earnings actually look like, that’s a good conversation to have before you set a price or talk to anyone else. Indiana Equity Brokers has worked through this process with hundreds of Indiana sellers, and we’ll tell you what holds up and what doesn’t before a buyer’s accountant does it for you.
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