Quazar Quips
©Volume 2, Issue 3
Add Backs That Turn Off Buyers
All buyers of businesses want to know what return on their investment they can expect to achieve. Part of figuring this out involves adding back some expenses to the company’s historical Net Income, as oftentimes some of the company’s historical expenses will not be incurred by the new owner. However, we sometimes see these add backs used indiscriminately to make a company’s earnings appear greater than is realistic. In this month’s newsletter, we would like talk about a few add backs that can turn off buyers.

The following is a short list of unrealistic add backs that may 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.

Scrutinizing add backs is an integral part of all buyers’ due diligence. We have found that addressing unrealistic add backs as early as possible by proving logical explanations for why certain add backs will not apply to new ownership yields the best results in working towards a successful sale.

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Thank you for reading Quazar Quips, a monthly newsletter discussing the Business Brokerage market for deals greater than $1 million in value. Each month, Quazar Quips will keep you informed about statistics, trends, and helpful thoughts within the Business Brokerage deal space. To read past issues of Quazar Quips, please see our website here. Stay tuned for next month’s newsletter, where we will discuss some key takeaways from the seminar that Quazar co-sponsored last month, which was titled “Insiders Secrets for Buying a Business.” If you or someone you know is thinking about selling their business, please contact Adam Webb at (763) 550-9555.