Tip #92: How Do Add Backs Affect Your Business Value?

Tip 92-Business Valuations Cartoon

One of the very first steps in the journey to sell your business is to receive a business valuation.

Some business owners feel concerned when they receive the results because it ends up being lower than they expected. When this happens, add backs are usually to blame.

Add backs are portions of business expenses that evaluators don’t think should be included in the estimated value. Usually, it’s because they are one-time expenses that the acquirer won’t end up needing to pay moving forward. These expenses are sometimes called Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), or Sellers Discretionary Earnings (SDE).

Determining Which Add Backs Are Legitimate

Of course, it’s always a good practice to comb through your valuation and ensure that any add backs cited by the evaluator were valid.

Common add backs include:

  1. Severance and Lawsuit Settlements: There is some room for discrepancy here, but as long as these types of expenses are unusual for the company, they tend to be legitimate add backs.
  2. Adjustments to Owner’s Compensation: Many business owners pay themselves large salaries and bonuses. There isn’t anything wrong with this, but the new owner may not be likely to give those same compensations to the new executives.
  3. Taxes and Benefits: The same way bonuses and bigger than normal salaries won’t be considered part of the business value, the taxes paid on those won’t be either.
  4. Personal Expenses: Running personal expenses through business accounts is not uncommon, especially in businesses that are closely held. When this happens, those expenses are not usually factored into the final business value.

Those are 4 of the most common add backs, but every business is unique. There are countless others you may encounter during your valuation process, so it isn’t possible to list all of them. However, if you know the right questions to ask yourself, you can usually determine whether an add back is not legitimate.

Try looking at your past records. If the expense seems to have occurred regularly, it probably isn’t a legitimate add back.

The other way to determine the add back’s legitimacy is to look into the future. If you think your buyer is likely to incur the same expense on a regular schedule, that’s another indicator of an illegitimate add back.

Of course, you can always rely on The Bridlebrook Group for help with your business valuation.