The Expenses You Can Add Back, and the Ones You Only Think You Can

A buyer is not pricing what your company earned. They are pricing what it will earn once you are gone, run by someone who pays themselves a market wage and does not put anything personal through it.

Getting from one number to the other is a schedule of adjustments. Each one is called an add-back, because you add it back to earnings. Owners typically build this schedule optimistically, and the optimism comes off in stages later, which is the most expensive way to discover you were wrong.

The three kinds, and what each is really claiming

Your own compensation, above market. If you pay yourself four hundred thousand dollars and the job you actually do is a two hundred thousand dollar job, the difference is not a cost of running the business. It is a distribution you routed through payroll.

Things that happened once. A legal settlement, a flood, a failed product launch, the cost of a system you installed and will not install again. The claim is that next year does not have this in it.

Spending that exists because you own the place. A vehicle nobody else would have, a family member on payroll who does not work in the business, a trip with two personal days attached.

Each category is making the same argument in a different costume: this expense will not follow the company to its next owner.

The rule that governs all three

Add back the excess, not the total.

This is where most schedules break, and it usually shows up in benefits. Owners add back the full cost of health insurance, life insurance, and retirement contributions, on the reasoning that these are owner benefits.

They are not. A buyer will employ someone to do your job and will provide that person benefits. Those costs continue. What does not continue is the part that sits above what the market provides, and that part is usually unusual in a specific way: a plan built to shelter your income, a policy written for estate purposes, a family member on the plan who does not work in the business.

The same test applies everywhere. The vehicle used for work and for weekends is not a full add-back; the personal share is. Your compensation is not an add-back; the amount above market is.

An owner who adds back totals rather than excesses produces a number that is too high by a predictable amount, and a buyer’s accountants find it in a week.

You do not get paid for what you cannot document

This is the part that costs real money, and it has nothing to do with whether your claim is true.

An add-back with an invoice behind it, a board minute, a policy document, or a line you can point to in the general ledger is a negotiation you can win. An add-back supported by your explanation of it is a line the other side strikes, and they strike it without much argument, because they do not have to argue. They simply do not include it.

Which creates an uncomfortable overlap. The category owners most want to add back, personal spending routed through the company, is frequently the category with the least documentation, for obvious reasons. If that describes your situation, fix it with your tax advisor and stop doing it, and understand that a buyer prices the last three years rather than the current one. The fix takes effect slowly.

Build it as it happens

A schedule assembled while a buyer is waiting looks exactly like what it is.

The adjustments that survive are the ones recorded when they occurred, with the evidence attached at the time, by someone who was not under pressure to reach a number. The ones that get struck are the ones reconstructed from memory and a bank statement eighteen months later.

There is also a volume problem. Diligence arrives as several hundred requests at once, and it arrives while you are still running the company. The owner who has to build the add-back schedule during that period is doing the hardest analytical work of the sale in the worst conditions of the sale.

What getting it wrong costs

Not a single large correction. A sequence of small ones.

The schedule gets worked through line by line. Each struck line lowers earnings, each lower earnings figure lowers the price, and each successful strike makes the next request easier to make. By the end an owner can be a long way from the number they opened with, and the drop happened in increments small enough that no single one justified walking away.

The company did not change. Only the evidence did.

More on this: The Multiple Gets the Headline. The Add-Backs Get the Money.; Your Tax Return Is Not What Your Company Earns.

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This is what we do. Prism Edge builds the recast before a buyer ever sees it, with the documentation attached to each line as it is built, so the schedule that reaches diligence is one that holds up rather than one that gets negotiated down. The work is cheapest long before anybody else’s clock is running.

The full chapter on proving what you actually earn is in The Business Sale, free to download here.

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General information, not legal, tax, or financial advice, and no advisor relationship is created by reading it. Rules change and the specifics of your situation matter. Always consult your own attorney and accountant before acting.