Identify Add-Backs To Avoid Over or Under or Over Valuing Your Business

by | Jun 7, 2021

Of the thousands of profit and loss statements that I’ve reviewed over the years to prepare and guide entrepreneurs toward their successful business exit, no two have ever been the same. Entrepreneurs, bookkeepers, and CPAs all do things differently.

The seemingly endless combination of variables generates unique P&Ls that need interpretation.  It requires scrutiny of the financials to ensure we aren’t overvaluing the business or leaving money on the table. A critical part of what we’re examining is the add-backs. 

An add-back is an owner benefit, either an accounting (non-cash) or a one-time, non-recurring expense, that does not carry forward to the new owner. Add-backs help to present a true, clear, and accurate depiction of Seller’s Discretionary Earnings (SDE) for potential business buyers. 

The biggest mistake that ecommerce entrepreneurs make when selling their business—on their own or through an inexperienced advisor—is not thoroughly reviewing their add-backs. It’s simple, easy, and disturbingly fast to lose tens of thousands of dollars without a deep dive into add-backs.

While there are countless add-backs your business might have, I’ll walk you through how to analyze some of the most common. Of course, this isn’t an exhaustive list, but it will help you get started.

#1: Owner’s Salary

The first, most obvious owner benefit is owner payroll. If an owner-operator’s business shows a net income of exactly zero dollars, but the owner takes a $300,000 salary, does that mean the business is worth zero? No, you add back the owner’s salary—below the net income line—to the add-back schedule, boosting SDE by $300,000 in this case.

There are exceptions to every rule, and this applies to the owner’s salary as well. If you work 60 hours a week, you cannot do a simple 100 percent add-back, because it’s not a reasonable expectation for the new owner to work 60 hours a week. Generally, that’s not what buyers are envisioning. 

For that $300,000 and a steady sixty-hour week, the buyer won’t consider it a 100 percent add-back. They’ll want to hire someone for at least 20 hours a week at say, $30,000 a year. At a 3x multiple, they’ll offset the overall value and drop their offer by $90,000 using their own math and logic. 

The same applies to two owners. Only one 40-hour-per-week salary is considered a direct add-back.

#2: Owner Payroll Tax Expenses

Being on salary, it’s easy to forget that your LLC or corporation pays a percentage of that salary in payroll taxes (social security, etc.). Clearly exhibit the math and create an add-back line for these taxes that your company paid in addition to your own salary.

Let me show you how important this can be using a sample tax expense pulled from a quarterly statement in North Carolina: the quarterly payroll amount is just under $43,000, and quarterly Total Employer Taxes are $3,264. Multiply this amount by four to annualize it and it becomes $13,056. Multiply that by your list price multiple (for example, three), and it becomes $39,168. 

Adds up fast, doesn’t it? If this is your payroll, and you’re properly honing in on your add-backs,  you’ve just caught$39,168 in value that could easily have gone unnoticed straight through your closing.

#3: One-Time Bookkeeper Expenses

If you’re like most entrepreneurs, you bootstrapped an idea into a successful business. You detest accounting and roughly grasp your numbers, so you focus on marketing instead of P&Ls, balance sheets, or cash flow statements. I understand, I did, too.

Now, after reviewing thousands of P&Ls for online businesses, I know that clear financials will help get you in a room with legitimate buyers. You will not sell your business if you can’t get in the room, which is why you need a P&L with a monthly view exported to Excel.

If you are anything like I was, and you need to hire a bookkeeper to pull data into QuickBooks Online or Xero from prior years, this is a one-time expense and absolutely an add-back. The cost of doing this will vary depending on the size and scope of the project, but this one-time cost (in advance of a sale) of getting your business financials cleaned, uncluttered, and transparent doesn’t transfer to the new owner – therefore it is an add-back. 

#4: Mobile Phones, Personal Meals, and Entertainment

Let’s assume your mobile phone is used for both personal and business calls. Does that mean it is only a partial add-back? Not when it comes to online businesses. 

Anyone buying an online business already has a mobile phone, so it’s not an additional expense or one that will carry forward. Let’s face it, if they don’t own a mobile phone, they should not be buying an online business.

As far as personal meals and entertainment, I am in no way endorsing or encouraging you to wholly write them off as business expenses. The reality is—it happens—especially with home-based online businesses that predominantly utilize Zoom and Skype calls for face-to-face meetings. Your CPA will make the proper adjustments on your tax returns, but this is rarely reflected in your P&Ls.

Not distinguishing your business meals and entertainment from personal activities on your P&L could cost you considerably during the sale of your business because of the erosion of trust.  However, most buyers will accept these types of add-backs without question.  

#5: Reduced Third-Party Fees or Packaging Costs

If you are like me, odds are that you had to hustle when you started your first ecommerce business. You probably scraped some cash together for your idea or product and did everything you could just to get the ball rolling. 

Over time, you made some changes to cut costs. In my case, I learned more about efficiencies and started outsourcing to VAs, stopped shipping by air, and redesigned the packaging to weigh less and have smaller dimensions for storage. 

After launching the business, your implemented ideas and processes for cost reduction are expenses that do not carry forward to the new owner—they are add-backs (if they were put in place within 12 months prior to the listing). 

Don’t Overlook the Importance of Add-Backs

These are just a few of the add-backs that you might find in your own ecommerce business—there are potentially dozens more. Every business is unique, so dig deep, ask questions, and have multiple conversations to capture all the details.

Add-backs should be used to paint the most complete picture of your business. Done right, they will shape an accurate valuation and build trust for the buyer. Overlooking them, on the other hand, could result in leaving tens to hundreds of thousands of dollars on the table at closing. 

Take the time to identify all your add-backs. If you do, you’ll ensure you don’t overvalue—or, even more importantly, undervalue—the business you’ve worked so hard to create and grow. 

For more advice on how to identify all the add-backs in your specific business, you can find The EXITPreneur’s Playbook on Amazon.

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