Business owners often “bury” some personal expenses in their business. Sometimes these expenses are
minor and sometimes these expenses are major. Regardless, these are called “add backs”.
Add backs to what?
The gold standard in what a business is worth is referred to as a multiple of EBITDA (Earnings Before
Interest, Taxes, Depreciation, Amortization). Owners typically view this as a benefit of being a business
owner. And, more expenses means lowering the basis upon which taxes are paid – and who doesn’t want
to stick it to Uncle Sam? But the story doesn’t end there.
When these personal expenses flow through the business – as stated above – they reduce EBITDA, or
income…
…until selling the business becomes relevant, that is. To account for these non-business expenditures, they
are added back to EBITDA – now referred to as “recasted EBITDA”.
The ethics of these discretionary expenditures is a topic for another article. The issue at hand is how
cumbersome it is to document for the buyer, and to the extent that they are buried so deeply from the entire world, they can affect the final selling price of the company. Let’s use that end of the spectrum for clarity in
an example:
A company with $1,000,000 of EBITDA, with a value multiple of 8x, equals a business valuation of
$8,000,000. For every dollar of discretionary expenditures that are lost – or cannot be supported in
“recasted EBITDA” is now equal to $8. Therefore, $10,000 in buried & unable to be documented as recast,
becomes $80,000 in lost value upon sale of the business. Further, while buyers often prioritize asset
purchases over stock purchases, they may shy away from stock purchases altogether – thereby forcing the
hand of the seller into an asset-only transaction.
This becomes a complicated issue that should be discussed well in advance of putting the business up for
sale and it should involve discussions with the company’s tax, wealth, and exit planning professionals.
For more on the intricate process of exit planning, feel free to reach out to StraightForward Financial Insights
LLC – with no obligation – (414) 301-9696 or email Jason@StraightForward.today.
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