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Add Backs a Buyer Accepts and Rejects

Most owners know their sales but not their true cash flow, and Dallas Business Brokers Firm sees add backs cause the biggest gap between hope and offers.

Here is how buyers sort them.

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The short version

  1. Buyers price your company on adjusted earnings, so every add back is worth the multiple times its size.
  2. Accepted add backs are real, documented and not part of running the business.
  3. One time income and owner draws are not earnings, and buyers will catch them.
  4. Unreported cash does not count toward value at all.

Why add backs matter

Main Street buyers value a company on seller's discretionary earnings, which is profit before the owner's pay, benefits and perks. Larger firms are priced on adjusted EBITDA, which swaps in a market rate manager.

Most companies trade around two to three times that figure. So a legitimate $30,000 add back can move the price by $60,000 to $90,000.

What buyers usually accept

  • The owner's salary and payroll taxes on it, for a working owner
  • Health insurance and retirement contributions for the owner
  • A personal vehicle or phone run through the business
  • One time costs, such as a lawsuit settlement, a move or a large repair that will not repeat
  • Family payroll for people who do not work in the business

Each one needs a paper trail. A buyer wants to see the receipt, the payroll record or the invoice.

What buyers reject

Buyers push back on add backs that look like normal costs under another name. Repairs that happen every year, a vehicle that really is a work truck and marketing you will have to keep paying all stay in the numbers.

Money from selling an old truck or from a bank loan is not operating income. Owner draws are not earnings either, since they never appear on the profit and loss statement.

Unreported cash

Cash that never reached the books cannot be proven, so it does not raise your price. Hiding income to save about 20 percent in tax can cost far more when the multiple is two to three times earnings.

A worked example

Say your profit before taxes is $200,000. You pay yourself $90,000, run $12,000 of health insurance through the company and paid $18,000 for a one time legal settlement. Added back, adjusted earnings are about $320,000.

At a multiple of 2.5, the company is worth about $800,000. Take away the settlement add back, because the buyer doubts it, and the figure drops by $45,000. That is why each line needs support.

How to prepare

Ask your CPA for a recast profit and loss statement for the last three years, with each add back listed and supported. Keep the statements current, since buyers weigh the trailing twelve months most.

Equipment heavy firms should expect a buyer to deduct maintenance spending from depreciation add backs. Plan for that so it is no surprise.

Once your numbers are clean, ask for a private price range. See also fixing customer concentration.

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