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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Do You Have an Exit Plan?
“Exit strategies may allow you to get out before the bottom falls out of your industry. Well-planned exits allow you to get a better price for your business.”
From: Selling Your Business by Russ Robb, published by Adams Media Corporation
Whether you plan to sell out in one year, five years, or never, you need an exit strategy. As the term suggests, an exit strategy is a plan for leaving your business, and every business should have one, if not two. The first is useful as a guide to a smooth exit from your business. The second is for emergencies that could come about due to poor health or partnership problems. You may never plan to sell, but you never know!
The first step in creating an exit plan is to develop what is basically an exit policy and procedure manual. It may end up being only on a few sheets of paper, but it should outline your thoughts on how to exit the business when the time comes. There are some important questions to wrestle with in creating a basic plan and procedures.
The plan should start with outlining the circumstances under which a sale or merger might occur, other than the obvious financial difficulties or other economic pressures. The reason for selling or merging might then be the obvious one – retirement – or another non-emergency situation. Competition issues might be a reason – or perhaps there is a merger under consideration to grow the company. No matter what the circumstance, an exit plan or procedure is something that should be developed even if a reason is not immediately on the horizon.
Next, any existing agreements with other partners or shareholders that could influence any exit plans should be reviewed. If there are partners or shareholders, there should be buy-sell agreements in place. If not, these should be prepared. Any subsequent acquisition of the company will most likely be for the entire business. Everyone involved in the decision to sell, legally or otherwise, should be involved in the exit procedures. This group can then determine under what circumstances the company might be offered for sale.
The next step to consider is which, if any, of the partners, shareholders or key managers will play an actual part in any exit strategy and who will handle what. A legal advisor can be called upon to answer any of the legal issues, and the company’s financial officer or outside accounting firm can develop and resolve any financial issues. Obviously, no one can predict the future, but basic legal and accounting “what-ifs” can be anticipated and answered in advance.
A similar issue to consider is who will be responsible for representing the company in negotiations. It is generally best if one key manager or owner represents the company in the sale process and is accountable for the execution of the procedures in place in the exit plan. This might also be a good time to talk to an M&A intermediary firm for advice about the process itself. Your M&A advisor can provide samples of the documents that will most likely be executed as part of the sale process; e.g., confidentiality agreements, term sheets, letters of intent, and typical closing documents. The M&A advisor can also answer questions relating to fees and charges.
One of the most important tasks is determining how to value the company. Certainly, an appraisal done today will not reflect the value of the company in the future. However, a plan of how the company will be valued for sale purposes should be outlined. For example, tax implications can be considered: Who should do the valuation? Are any synergistic benefits outlined that might impact the value? How would a potential buyer look at the value of the company?
An integral part of the plan is to address the due diligence issues that will be a critical part of any sale. The time to address the due diligence process and possible contentious issues is before a sale plan is formalized. The best way to address the potential “skeletons in the closet” is to shake them at this point and resolve the problems. What are the key problems or issues that could cause concern to a potential acquirer? Are agreements with large customers and suppliers in writing? Are there contracts with key employees? Are the leases, if any, on equipment and real estate current and long enough to meet an acquirer’s requirements?
The time to address selling the company is now. Creating the basic procedures that will be followed makes good business sense and, although they may not be put into action for a long time, they should be in place and updated periodically.
© Copyright 2015 Business Brokerage Press, Inc.
Photo Credit: dhester via morgueFile
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The Devil May Be in the Details
When the sale of a business falls apart, everyone involved in the transaction is disappointed – usually. Sometimes the reasons are insurmountable, and other times they are minuscule – even personal. Some intermediaries report a closure rate of 80 percent; others say it is even lower. Still other intermediaries claim to close 80 percent or higher. When asked how, this last group responded that they require a three-year exclusive engagement period to sell the company. The theory is that the longer an intermediary has to work on selling the company, the better the chance they will sell it. No one can argue with this theory. However, most sellers would find this unacceptable.
In many cases, prior to placing anything in a written document, the parties have to agree on price and some basic terms. However, once these important issues are agreed upon, the devil may be in the details. For example, the Reps and Warranties may kill the deal. Other areas such as employment contracts, non-compete agreements and the ensuing penalties for breach of any of these can quash the deal. Personality conflicts between the outside advisers, especially during the
due diligence process, can also prevent the deal from closing.
One expert in the deal-making (and closing) process has suggested that some of the following items can kill the deal even before it gets to the Letter of Intent stage:
- Buyers who lose patience and give up the acquisition search prematurely, maybe under a year’s time period.
- Buyers who are not highly focused on their target companies and who have not thought through the real reasons for doing a deal.
- Buyers who are not willing to “pay up” for a near perfect fit, failing to realize that such circumstances justify a premium price.
- Buyers who are not well financed or capable of accessing the necessary equity and debt to do the deal.
- Inexperienced buyers who are unwilling to lean heavily on their experienced advisers for proper advice.
- Sellers who have unrealistic expectations for the sale price.
- Sellers who have second thoughts about selling, commonly known as seller’s remorse and most frequently found in family businesses.
- Sellers who insist on all cash at closing and/or who are inflexible with other terms of the deal including stringent reps and warranties.
- Sellers who fail to give their professional intermediaries their undivided attention and cooperation.
- Sellers who allow their company’s performance in sales and earnings to deteriorate during the selling process.
Deals obviously fall apart for many other reasons. The reasons above cover just a few of the concerns that can often be prevented or dealt with prior to any documents being signed.
If the deal doesn’t look like it is going to work – it probably isn’t. It may be time to move on.
© Copyright 2015 Business Brokerage Press, Inc.
Photo Credit: jppi via morgueFile
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Family Businesses
How to Successfully Sell a Family Business
Introduction
Selling a family business can be a complex and emotional process. Whether you’re planning to retire, pursue other ventures, or simply feel it’s time to move on, understanding the steps involved is crucial for a successful sale. This guide will walk you through the essential aspects of selling a family business, ensuring you get the best value and transition smoothly.
Why Sell a Family Business?
Personal Reasons
- Retirement
- Pursuing new opportunities
- Health issues
Business Reasons
- Market conditions
- Financial struggles
- Lack of succession planning
Preparing Your Family Business for Sale
Financial Preparation
- Audit Financial Statements: Ensure your financial records are accurate and up-to-date.
- Valuation: Obtain a professional business valuation to understand your business’s worth.
Operational Preparation
- Streamline Operations: Make your business as efficient as possible.
- Document Processes: Ensure all business processes are well-documented.
Emotional Preparation
- Family Consensus: Ensure all family members are on the same page.
- Professional Counseling: Consider seeking advice from a business counselor.
Finding the Right Buyer
Types of Buyers
- Strategic Buyers: Companies looking to expand their market share.
- Financial Buyers: Investors looking for profitable businesses.
- Individual Buyers: Entrepreneurs looking for new opportunities.
Marketing Your Business
- Confidentiality Agreements: Protect sensitive information.
- Professional Brokers: Utilize business brokers to find potential buyers.
Negotiating the Sale
Key Considerations
- Price: Ensure the price reflects the business’s true value.
- Terms: Understand the terms of the sale, including payment structure and transition period.
Legal Aspects
- Contracts: Have a lawyer review all contracts.
- Compliance: Ensure the sale complies with all legal requirements.
Closing the Deal
Final Steps
- Due Diligence: Allow the buyer to conduct due diligence.
- Transition Plan: Develop a plan for transitioning the business to the new owner.
Celebrating the Sale
- Family Celebration: Mark the occasion with a family celebration.
- Future Plans: Discuss future plans and opportunities.
Common Mistakes to Avoid
Lack of Preparation
- Financial Discrepancies: Ensure all financial records are accurate.
- Operational Inefficiencies: Streamline operations before the sale.
Emotional Decisions
- Family Disagreements: Resolve any family disputes before the sale.
- Unrealistic Expectations: Have realistic expectations about the sale price and process.
Conclusion
Selling a family business is a significant decision that requires careful planning and execution. By following these steps, you can ensure a smooth and successful sale, securing the best possible outcome for your family and your business.
Call to Action
Ready to sell your family business? Contact our experienced brokers today for a free consultation and take the first step towards a successful sale!
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Two Similar Companies ~ Big Difference in Value
Consider two different companies in virtually the same industry. Both companies have an EBITDA of $6 million – but, they have very different valuations. One is valued at five times EBITDA, pricing it at $30 million. The other is valued at seven times EBITDA, making it $42 million. What’s the difference?
One can look at the usual checklist for the answer, such as:
- The Market
- Management/Employees
- Uniqueness/Proprietary
- Systems/Controls
- Revenue Size
- Profitability
- Regional/Global Distribution
- Capital Equipment Requirements
- Intangibles (brand/patents/etc.)
- Growth Rate
There is the key, at the very end of the checklist – the growth rate. This value driver is a major consideration when buyers are considering value. For example, the seven times EBITDA company has a growth rate of 50 percent, while the five times EBITDA company has a growth rate of only 12 percent. In order to arrive at the real growth story, some important questions need to be answered. For example:
- Are the company’s projections believable?
- Where is the growth coming from?
- What services/products are creating the growth?
- Where are the customers coming from to support the projected growth – and why?
- Are there long-term contracts in place?
- How reliable are the contracts/orders?
The difference in value usually lies somewhere in the company’s growth rate!
© Copyright 2015 Business Brokerage Press, Inc.
Photo Credit: jeltovski via morgueFile
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