What Are Valid Addbacks in a Business Sale?

When adjusting cash flow for a business sale, it's essential to focus on valid addbacks. These are expenses added back to the business’s profit to present a clearer picture of the company’s true cash flow, which can help buyers and sellers agree on a fair valuation. Here’s a guide on valid addbacks you can use to adjust cash flow during a business sale:

1. Owner Compensation and Personal Expenses

Small business owners often take a salary beyond market rates or charge personal expenses to the business to minimize taxes. Addbacks include:

• Excessive owner salaries: Add back the portion of salary that exceeds what would be necessary to pay a typical manager performing the same role.
• Personal expenses disguised as business expenses: Cars, travel, or meals that don’t relate to business operations.

Why it matters: Buyers want to see what the cash flow looks like without the owner's personal spending involved.

2. One-Time or Non-Recurring Expenses

Some costs are unusual and will not affect future cash flows. Examples include:

• Legal fees from one-off lawsuits or settlements.
• Moving costs or lease termination penalties.
• Costs associated with specific marketing campaigns or events that won’t recur.

Tip: Highlighting these expenses gives buyers confidence that they won’t reoccur under their ownership.

3. Discretionary Expenses

These include expenses that are optional or unnecessary for core business operations, such as:

• Charitable donations.
• Extra travel perks for the owner or key employees.
• Subscriptions or memberships for non-essential activities.

Note: Buyers often adjust cash flow by adding back these expenses to reflect the operational profits more accurately.

4. Non-Cash Expenses

Expenses that do not impact cash flow, such as:

• Depreciation, amortization, interest
• Certain write-offs related to old inventory or equipment.

Why it matters: These addbacks help clarify actual cash flow since depreciation and amortization reduce net income on paper but not the cash in the bank.

5. Owner Benefits and Fringe Benefits

Owners sometimes take perks that aren't directly related to business needs:

• Health insurance or retirement contributions beyond what would be offered to a typical employee.
• Club memberships, company cars, or travel unrelated to business.

Advice: Properly presenting these benefits as addbacks ensures that future profits won’t be weighed down by unnecessary costs.

Final Thoughts on Addbacks

Addbacks provide a more accurate measure of a company’s Seller’s Discretionary Earnings (SDE), helping both sellers and buyers establish a fair valuation. Clean and clear financials increase trust, speed up negotiations, and attract serious buyers. Remember to document these adjustments thoroughly with supporting evidence to avoid disputes during due diligence.

This post was originally published at https://www.ericimendelsohn.com/