Add-Backs

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What It Means

An Add-Back is an expense that is added back to the profits of a company for the purpose of improving the profitability of the company on paper. Add-Backs represent expenses that are not expected to continue after a company has been sold, so they are removed from the financials to represent the expected future profitability of the company after an Acquisition. Only expenses that have previously been deducted from the profits can be added back.

Add-Back adjustments do not happen in a company’s books used for tax accounting purposes. These items are usually detailed in a separate set of financials that are prepared specifically for the purpose of marketing a business for sale.

Common categories of Add-Backs include:

• Excess Owner Compensation - It is common for business owners who have built large and successful businesses to pay themselves well. The difference between what an owner pays themselves and what they would expect to pay someone else to manage the company on their behalf is usually the amount that can fairly be added back. If an owner pays themselves from the company but doesn’t manage the business, then they might be able to Add-Back the entire amount of their compensation.

• Friends and Family Compensation - It is also common for an owner to employ a spouse or other relative in the business. If these individuals do not fulfill roles that are expected to continue after the sale of the business, then it is fair to add those salaries back as well.

• Taxes and Benefits - When adding back compensation, don’t forget to add back the taxes and benefit costs that the company incurred as well.

• Personal Expenses - Personal expenses, such as travel, meals, vehicles, and memberships that are not expected to continue with a new owner may be added back as well.

• Other Non-Recurring Expenses - Any non-standard or unusual expense that is not expected to continue after an Acquisition may be fairly added back. Some examples include expenses related to legal settlements, discontinued operations, and costs associated with recovering from a natural disaster.

Why It’s Important

Add-Backs are extremely important because they can have a substantial impact on the Enterprise Valuation of a business. Add-Backs directly affect the apparent profitability of a company, and companies are most often valued based on a multiple of their profitability. Thus, if a company is being valued at 5 times EBITDA, every $50k of Add-Backs would imply an additional $250k of Enterprise Valuation. It’s easy to see why Add-Backs often become a significant source of disagreement between Sellers and Buyers in an Acquisition negotiation.

Related Terms

• Acquisition

• Buyer

• Due Diligence

• Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”)

• Enterprise Value

• Free Cash Flow

• Multiple

• Seller

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