When you sell a business, the price is usually a multiple of earnings. That makes the earnings figure the most important number in the deal. And the earnings figure buyers argue about is rarely your tax return net income. It is adjusted EBITDA, built by starting with EBITDA and adding back costs that will not continue under a new owner.
Add backs can be completely legitimate. They can also be the fastest way to lose a buyer’s trust. Here is how to tell the difference.
What an add back is
An add back, sometimes called a normalization adjustment, is an expense you remove from historical results because it does not reflect the ongoing cost of running the business. Every dollar added back raises adjusted EBITDA, and at a multiple of five, each dollar of add back can mean five dollars of price.
That math is exactly why buyers scrutinize them.
Why buyers are skeptical
Buyers have data on their side. S&P Global Ratings has tracked EBITDA add backs in leveraged deals for years. In its latest study, add backs made up 26% of management adjusted EBITDA for 2023 deals, after peaking at 32% in 2021. Over its seven year performance study, S&P found that only 8% of companies met or exceeded their earnings projections in the first year after the deal, and the median miss was 32%.
Those are larger transactions than most small and midsize sales. But buyers and lenders in the lower middle market read the same research, and they bring the same skepticism to your deal.
Add backs buyers usually accept, and the ones they challenge
| Add back | Usually accepted when | Pushback when |
|---|---|---|
| Owner compensation above market | Adjusted to what a replacement manager would cost | The owner role still needs to be filled and nobody priced it |
| Personal expenses run through the business | Clearly documented, like a family vehicle or personal travel | Vague categories with no receipts |
| One time legal or settlement costs | Truly isolated event with paperwork | Legal costs show up every year in some form |
| Transaction costs for the sale | Advisor and legal fees tied directly to the sale | Mixed with ordinary professional fees |
| Non recurring repairs or relocation | Clear start and end, invoices available | Repairs that are really deferred maintenance |
| Rent adjusted to market | Owner owns the building and rent is off market | Lease terms are not agreed with the buyer |
| Projected savings or “run rate” synergies | Rarely accepted without proof already in the results | Based on plans rather than actual results |
Red flags that cost sellers credibility
- Recurring “one time” costs. If a cost appears in three of the last three years, it is not one time.
- Add backs with no support. Every adjustment should tie to invoices, contracts or payroll records.
- Ignoring negative adjustments. Honest normalization works both ways. Below market rent paid to a related party, an unpaid family member working full time, or deferred maintenance all reduce EBITDA.
- Revenue add backs. Claiming lost sales would have happened is almost never accepted.
- Books that do not tie. If the profit and loss does not match tax returns and bank deposits, buyers will doubt every add back built on it.
An illustrative example
Illustrative example, not a specific client. A South Florida HVAC services company reports $900,000 of EBITDA. The owner lists $450,000 of add backs: $200,000 of owner salary above market, $60,000 of personal vehicles and travel, $40,000 of one time legal fees, and $150,000 for a “lost contract” the owner believes would have renewed.
A buyer’s quality of earnings team would likely accept most of the salary and personal items if documented, question the legal fees if similar costs appear in other years, and reject the lost contract entirely. Adjusted EBITDA might land closer to $1.15 million than the $1.35 million the owner expected. At a five times multiple, that gap is about $1 million in price. Finding that out before going to market is much cheaper than finding it out in diligence.
How to prepare your add backs before you sell
Clean up the books first
Adjustments are only credible on top of accurate, reconciled financials. Monthly bookkeeping with a real close is the foundation.
Build an add back schedule with support
For each adjustment, list the amount by year, the reason, and the documents that prove it. Treat it like you are presenting to a skeptical lender, because you are.
Stop running personal costs through the business
The cleanest add back is the one you never need. Owners planning a sale in two or three years should start separating personal spending now.
Get an independent view
A sell side QoE and valuation tests your add backs the way a buyer will, so you set price expectations on numbers that hold up. If you are on the other side, our buy side QoE team does the same work to protect you from paying for adjustments that will not last.
Frequently asked questions
What are EBITDA add backs?
They are adjustments that remove expenses from historical results because those costs will not continue under new ownership, such as above market owner pay, personal expenses, or genuine one time costs.
What add backs do buyers usually accept?
Well documented owner compensation adjustments, personal expenses, transaction costs and clearly isolated one time items are most commonly accepted. Projected savings and lost revenue claims are rarely accepted.
Can add backs reduce EBITDA too?
Yes. Normalization works both ways. Below market related party rent, unpaid family labor or deferred maintenance can all reduce adjusted EBITDA.
How do I make my add backs credible?
Start from clean, reconciled books, document every adjustment with invoices or contracts, and have an independent sell side quality of earnings review test them before you go to market.
Let’s talk about your numbers
If you are thinking about selling and want to know which add backs will hold up, we would be glad to review them with you in a free meeting. No pressure, just an honest read before buyers see your numbers. Visit our sell side QoE and valuation page or reach out to our Miami team.
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