There are a number of ways to value a business. A common valuation method buyers use involves applying a multiple to the company’s earnings before interest, taxes, depreciation and amortization (EBITDA). While business owners who intend to sell all or part of their business have many options to increase the transaction multiple, one way to unlock value is to identify “add backs” to increase EBITDA. For example – at a 6x EBITDA multiple, $100,000 in add backs can result in $600,000 in additional value.
Types of Add Backs
In general, add backs fall into one of the following categories: discretionary, non-operating, non-recurring, and accounting adjustments. Add backs and adjustments will vary from company to company, but understanding these major categories is helpful in identifying potential increases to EBITDA, and thus business value.
- Discretionary: Discretionary add backs are expenses that do not necessarily contribute to the operating performance of the company or are unlikely to continue under a different owner. Examples of discretionary expenses may include above-market officer compensation, travel, club dues, professional sports tickets, etc. When adjusting for excess compensation, it is important to consider payroll taxes, insurance, and benefits related to any excess wages.
- Non-operating: As with the discretionary add backs, non-operating add backs are expenses that are not required in or related to the true operating performance of the company. Oftentimes, these are related to non-operating assets or liabilities, such as real estate or vehicles.
- Non-recurring: Non-recurring add backs are expenses that are unlikely to occur again in the future. Examples of non-recurring expenses may include legal expenses, consulting or other professional fees, transaction-related costs, one-time technology upgrades, facility relocation expenses, bad debt expense, and donations, among others. Business owners may also include certain employee wages as non-recurring if there have been workforce reductions in which the position is not going to be needed going forward. As noted with officer compensation, one should consider payroll taxes, insurance, and other benefits and burden related to non-recurring wages.
- Accounting Adjustments: Accounting adjustments may be required for consistency with generally accepted accounting principles (“GAAP”), including inventory reporting, equipment purchases that should be capitalized, and classification adjustments between operating expenses and cost of goods sold. Additionally, buyers often calculate EBITDA based on operating income, and may not include certain income items included “below the line” in other income. These items could include vendor rebates or credits that may need to be reclassified against the corresponding operating expense account as an accounting add back.
- Carve-out Accounting: While not always considered as an “add back,” there are often certain operations or subsidiaries that are not to be included as part of a transaction. These excluded elements may not have separately-reported financial statements, and certain accounting procedures may be necessary to carve-out income and expenses.
P&N’s dedicated team of valuation and transaction professionals has a depth of experience to help businesses navigate potential add backs and the many challenges involved in an anticipated sale. Contact us to discuss strategies and understand add backs that can help improve your transaction value.