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Add-backs

Add-backs are costs added back to reported profit to show what a business would earn under a new owner. They raise SDE and adjusted EBITDA, so each one needs evidence.

Also called add-back

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Definition

Add-backs are expenses added back to reported profit to show what a business would earn under a new owner. Common examples are the owner's own pay and perks, genuinely one-off costs and personal spending run through the business. They are the building blocks of SDE and adjusted EBITDA, and they are where many disagreements about price begin.

Seller's discretionary earnings (SDE)

Seller's discretionary earnings is the yearly financial benefit a business gives one full-time working owner, before financing costs, non-cash charges and one-off spending.

Adjusted EBITDA

Adjusted EBITDA is EBITDA after normalising adjustments, showing what a business would earn with a paid manager in the owner's seat. Larger small-business deals are usually priced on it.

Worked example

Lindenhof Bakery GmbH is a fictional German business with net profit before tax of €150,000. The seller proposes four add-backs:

  • €60,000 owner's salary: holds up, provided only one working owner is added back.
  • €8,000 for a family car used privately: holds up if the car leaves with the seller.
  • €12,000 for a "one-off" oven repair: doubtful, because the ovens have needed repairs most years.
  • €20,000 of marketing "a new owner could cut": weak, because sales may fall without it.

The seller's SDE is €250,000. A cautious buyer who accepts only the first two arrives at €218,000. At a fictional multiple of 3, that €32,000 gap is worth €96,000 of price.

Net profit before tax

Net profit before tax is what a business earns after all its costs, including interest and depreciation, but before tax on its profits. It is the starting point for SDE and EBITDA.

Why buyers care

Every add-back raises earnings, and the multiple turns it into several times its value in price. Ask for evidence for each one: invoices, bank statements and a clear reason the cost will not recur. Watch for costs described as one-off that appear every year, for family members paid above or below a market rate and for cuts that would quietly damage the business.

On larger deals, a quality of earnings review tests add-backs formally. On smaller ones, you may need to do that work yourself before you make an offer.

Quality of earnings

A quality of earnings review is an accountant's analysis of whether a business's reported earnings are accurate, sustainable and correctly adjusted. It is not an audit.

Related terms

  • Seller's discretionary earnings (SDE)

    Seller's discretionary earnings is the yearly financial benefit a business gives one full-time working owner, before financing costs, non-cash charges and one-off spending.

  • Adjusted EBITDA

    Adjusted EBITDA is EBITDA after normalising adjustments, showing what a business would earn with a paid manager in the owner's seat. Larger small-business deals are usually priced on it.

  • Normalised earnings

    Normalised earnings are profits restated to show what a business would earn in a typical year under a new owner, after removing one-off items and correcting costs that are not at market rates.

  • Quality of earnings

    A quality of earnings review is an accountant's analysis of whether a business's reported earnings are accurate, sustainable and correctly adjusted. It is not an audit.

  • Net profit before tax

    Net profit before tax is what a business earns after all its costs, including interest and depreciation, but before tax on its profits. It is the starting point for SDE and EBITDA.

Guides

  • Add-backs: which hold up and which do not

    Add-backs turn the profit in the accounts into the earnings on a listing, and each one is paid for several times over in the price. This guide shows how to test them and which usually survive.

    9 minutes to read

  • SDE and EBITDA explained with worked examples

    SDE and adjusted EBITDA both restate a business's profit for a buyer, but they answer different questions. This guide builds each one up line by line for two fictional businesses and shows which to use.

    9 minutes to read

  • Due diligence: what to check and in what order

    A sequence for due diligence that tests what could end the deal first, while it is still cheap to find out, and leaves the detailed and expensive work until the deal looks sound.

    10 minutes to read

Red flags

  • Large or undocumented add-backs

    Add-backs raise the earnings a price is based on. When they are large, vague or unsupported, much of the asking price rests on claims rather than records.

    Severity: price it inFinancials

  • Family or related staff paid off-market rates

    Relatives who work for little or nothing make profit look higher than it will be under a new owner, and pay for relatives who do little work is often presented as an add-back. Restate their pay at market rates before you apply a multiple.

    Severity: price it inOperations and people

  • Related-party transactions

    Deals between the business and its owner, their family or their other companies may not be at market rates, and many will not survive the sale.

    Severity: price it inFinancials

  • Unrecorded cash sales

    A seller who says the business takes more cash than the books show is asking you to pay for income nobody can verify, and may be passing on a tax problem.

    Severity: price it inFinancials

Free tools

  • See a low, likely and high value from the figures you have, and whether the asking price holds up.

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