One of the things I talk about all the time with business owners is add-backs. And honestly, this
It is one of the most misunderstood parts of preparing a business for sale.
What is an Addback?
First, let’s define the term. Add-backs are expenses the business currently pays that a new owner is unlikely to incur. These can include personal expenses, one-time costs, or discretionary services that won’t continue after the sale. By identifying legitimate add-backs, we remove those expenses from the financials and add them back to the company’s cash flow, providing a clearer picture of the business’s true earning potential.
As a business broker here in the California Bay Area, I look at financial statements every single day. I constantly review profit and loss statements, tax returns, balance sheets, and SBA lender feedback across many industries. And I can tell you firsthand, the issue of addbacks comes up in every deal.
A lot of owners assume that if an expense runs through the business, it automatically counts as
an add-back. That’s simply not true.
When a buyer, and more importantly, an SBA lender, looks at your financials, they’re trying to
determine what the business is truly earning for an owner. That number directly impacts value,
financing, and ultimately whether your business is sellable at the price you want.
A Real Example
I worked with a business owner recently who believed the business was worth substantially
more than what the market would support. On paper, the adjusted earnings looked very strong.
But when we started going through the add-backs line by line, a large portion of them were
personal expenses running through the business. There were vacations, family travel, Amazon purchases, meals, personal vehicle costs, and miscellaneous spending buried throughout the P&L.
From the owner’s perspective, he viewed it all as discretionary spending, so he assumed it should be added back. The problem was that the SBA lender didn’t see it that way. The lender accepted the standard adjustments:
- Owner salary
- Payroll taxes
- Depreciation
- Interest expense
- Retirement contributions
But they pushed back hard on many of the personal expenses. And that changed the entire deal. Once the lender recalculated the true cash flow, the buyer no longer qualified for the original purchase price. The business itself was still solid, but cash flow no longer supported the level of SBA debt the seller had expected.
That’s the part many owners don’t realize: The bank is not underwriting your lifestyle. They
are underwriting dependable cash flow.
What Counts as a Legitimate Add-Back?
- Depreciation
- Amortization
- Interest expense
- Owner W-2 salary
- Owner payroll taxes
- A spouse’s salary if they are not actively working in the business
- Personal medical insurance
- Personal vehicle expenses run through the business
- Owner retirement contributions
- One-time, non-recurring expenses
Those are normal and commonly accepted.
What Is Not a Legitimate Add-Back?
- Vacations
- Cash distributions
- Costco purchases
- Amazon purchases
- Groceries
- Miscellaneous personal spending hidden in expense categories
Why This Matters More Than Most Owners Realize
If your financials rely heavily on questionable add-backs, two things usually happen:
- Your valuation becomes harder to justify
- Your buyer pool shrinks significantly
Why?
Because SBA lenders are conservative. If they don’t accept the add-backs, the buyer may no
longer qualify for financing at your asking price. At that point, you’re looking for a cash buyer or a deal with heavy seller financing, which narrows the buyer pool.
What You Should Do Now
Most business owners spend years trying to minimize taxes. I understand why. But some of
those same strategies work against you when it’s time to sell. You can’t aggressively suppress income for years and then suddenly expect a buyer or lender to pay top dollar based on adjustments that aren’t fully defensible.
If you think you may want to sell your business in the next two to three years, now is the time
to start cleaning things up. Run cleaner books. Reduce questionable expenses. Show stronger true earnings. Because at the end of the day, the cleaner and more defensible your numbers are, the easier your business will be to sell, and the more confidence buyers and lenders will have in paying a premium price.
If you want to learn which of your business’s expenses might be considered defensible addbacks, and what your business could be worth in today’s market, click here for a confidential review. Im happy to answer any questions.