|Add Backs That Turn Off Buyers|
- Owner’s Salary – Oftentimes, business owners take a larger salary than would be considered the market rate for their position. In these cases, adding back a portion of the owner’s salary is appropriate, as the new owner will want to pay themselves a market rate salary or hire someone at a market rate to fill the position. Where we see problems with this add back is when the entire owner’s salary is added back when calculating Adjusted EBITDA or Free Cash Flow. Even if a business owner claims to not be involved in the business, in our experience, adding back the entire owner’s salary is rarely justifiable. Please keep in mind that when calculating Seller’s Discretionary Earnings (SDE), all of the owner’s salary should be added back. For a quick refresher on some commonly used financial metrics, Please click here for a past edition of Quazar Quips which addresses the topic.
- Owner’s Expenses – Similar to the owner’s salary above, there are often owner expenses which may not be incurred by future owners, and these are appropriate add backs. However, we have seen owner’s health insurance, dental insurance, and vehicle expenses be treated as add backs. The new owner is very likely going to want insurance and a vehicle expensed through the business, so potential buyers should carefully vet all owner expense add backs.
- Employee Benefits – We have seen add backs where employees receive above market rate health insurance, so the difference between market rates and the current rates are added back. However, the employees likely expect the quality of their current health insurance to continue with new ownership, so this would likely be an unrealistic add back.
- Employee Bonuses – Employees view bonuses as part of their compensation that they can expect going forward, even if the bonuses are variable or discretionary. A new owner who eliminates all bonuses will have a hard time retaining and motivating their workforce, so treating the bonuses as an add back may not be appropriate.
- Underperforming customers – Sometimes businesses have unprofitable customers and typically take action to correct these instances. However, this process is just part of doing business. Therefore, looking backwards at unprofitable customers and applying an add back for the profit that should have been realized is likely unrealistic, as there is no assurance that the business will not also have unprofitable customers going forward.