Understanding Add-Backs and EBITDA: Boosting Business Valuation for a Successful Sale
When an entrepreneur sells their business, the goal of a skillful intermediary is to craft a persuasive argument regarding the value of the company. Most business owners intend to fund their retirement through the sale of the small businesses they have built over time, so every dollar that shows up on the bottom line, also known as net adjusted EBITDA (Earnings Before Income Taxes, Depreciation, and Amortization), matters.
How to Calculate EBITDA
Most businesses are assessed based on their profits, so a competent intermediary will work with a business owner to pinpoint "optional" costs that can be re-added to the taxable income reported to the IRS. These "add-backs" are financial changes made to a company's financial records to reflect its actual profits.
As many business owners will readily confirm, the expenses reported to the IRS incorporate a lot of "optional" costs. Put another way, most owners will run personal expenses through the business. Owners should get credit for the actual profit potential of the business, not just the profits reported to the IRS after all of their personal or discretionary purchases.
Common Examples of Add-Backs
Add-backs can take various forms, but some common examples include:
One-Time Expenses:
Costs that are unlikely to occur again in the future, such as legal fees linked to a one-off lawsuit or a loss from a discontinued product line.
Owner Compensation:
If the owner of a business takes a salary or other pay that is higher than the market rate, an add-back can be made to adjust for this. This is especially common when a spouse or family member draws a market salary from the business but only works part-time (or not at all!).
Personal Expenses:
Sometimes, business owners use company money to pay for personal expenses. These costs can be added back to reflect the actual profitability of the company. Examples include buying expensive gifts, leasing luxury vehicles, or purchasing personal tech devices under business expenses.
Depreciation and Amortization:
These are non-cash expenses included in the company's financial records but don't impact its cash flow. To arrive at a more precise representation of the company's profitability, an add-back can be made to remove these expenses from the calculation.
Common Add-Backs in Detail
Here are some of the most common add-backs we see:
Owner’s Salary and Bonuses
Compensation of Non-Working Family Members
Personal Vehicle Purchases and Leases
Owner’s Insurance (e.g., Life Insurance, Health Insurance)
Owner’s Retirement Benefits and Plans
Charitable Contributions
Interest Expenses:
All paid interests on credit cards, bank loans, or lines of credit need to be added back to the bottom line, as it is generally expected these loans are paid off at the time of the closing, and the new buyer will not be responsible for these payments.
Importance of Legitimate and Justifiable Add-Backs
Add-backs must be legitimate and justifiable as they can have a major impact on a business's valuation. By adjusting for non-recurring or non-operating expenses, the company's actual profitability can be more accurately reflected, leading to a higher valuation. These adjustments can more than double the business's earnings, resulting in what is known as “Seller’s Discretionary Earnings.”
It's important to note that inaccurate or fraudulent add-backs can be illegal and have legal consequences for both the buyer and seller. Add-backs are a common part of business sales used to adjust financial records for non-recurring or non-operating expenses, providing a more precise picture of the company's profitability, which can increase the business's valuation.
About Dr. Allen Nazeri
Dr. Allen Nazeri, also known as Dr. Allen, has over 30 years of experience as an entrepreneur around the world. Currently, he holds the position of Managing Director at American Healthcare Capital and serves as Managing Partner at PRIME Exits. Over his career, Dr. Allen has actively provided strategic consulting on growth to leadership teams of private and public companies to prepare them for a successful exit.
With a Dental Degree from Creighton University and an MBA in Mergers & Acquisitions and Investment Banking from the University of Bedfordshire, Dr. Allen is also the author of the book "Value Engineering: Strategies to Increase the Value of Your Clinic by 10 Times and Dominate the Market!" As part of his services, Dr. Allen generously offers a free valuation to business owners ready to start a partial or complete exit strategy. Leveraging his vast network, Dr. Allen collaborates with many strategic buyers and private equity firms, as well as select institutional investors actively seeking high-quality healthcare investments. Remarkably, Dr. Allen takes direct responsibility for the successful sell-side representation of an aggregate enterprise value of nearly $750 million annually.
If you wish to contact him, feel free to email Allen@ahcteam.com or Allen@pexits.com.
Comments