Understanding Add-Backs

In a typical mergers & acquisitions (M&A) transaction, both parties (buyers and sellers) search for ways to understand the true value and earning capacity of the target company. Buyers want the unvarnished truth, and sellers have an obvious incentive to present favorable figures. One approach to presenting numbers to the buyer while they are performing due diligence on a target company is to include add-backs to profit & loss statements. This blog will provide an introduction to add-backs and address some broad considerations of this financial tool. 

What is an Add-Back?

To put it simply, an add-back is an expense (either ongoing or one-time) that can be added back to the EBITDA (earnings before interest, taxes, depreciation, and amortization) of a particular company in order to present a clearer picture of the cash flow. In other words, the buyer wants to know what kind of profits to expect after the transaction is completed, and some types of expenses obscure this picture. 

Examples of Add-Backs

There are countless add-backs that the owner of a target company can choose to include on profit statements. Family-owned businesses often have myriad add-backs that can be cumbersome to sort through when performing due diligence. That said, some of the common examples of add-backs you might encounter on financial documents are:

 

  • Executive owner compensation. Some owners deem it appropriate to take a salary that could be considered above the industry average. For instance, the owner of a small consulting firm taking a $300,000 salary, however unrealistic, would likely be an add-back. Beware of owners adding back their entire earnings, though; you may be a more hands-on owner. 
  • Personal expenses paid for with business money. Again, this is common with mom-and-pop and other small businesses. 
  • Large judgments or settlements. You are well aware that every business has to deal with its fair share of frivolous lawsuits. However, many businesses have to deal with a legitimate claim that ends up getting settled or ruled on by a judge. This isn’t frequent, though. So, it is sensible to add back the largest judgment or settlement in your company’s history into the EBITDA. 

 

Determining which expenses are legitimate add-backs can be difficult. Buyers who encounter what they believe to be illegitimate add-backs will begin to question the entire transaction. Remember that add-backs are expenses that the new owner should not expect to incur post-transaction. 

Conclusion

Before you sell your company or buy another one, we would love to help you understand the value of partaking in such a significant transaction. Our business coaching services help entrepreneurs find their Why, How, and When. To find a purpose going forward, give Soterian a call at 704-755-5145.

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