Add Backs for Adjusted EBITDA
If you're a founder thinking about selling your business, you've likely heard the term "Adjusted EBITDA." This financial metric is a key part in any business sale and can impact the final sale price. Adjusted EBITDA is basically the way to measure a company's earnings before interest, taxes, depreciation, and amortization - with certain adjustments made for one-time or specific-owner expenses. Here are some tips to help you navigate it:
Tips for Understanding the Sale of Your Business
While the process of moving from Net Income to EBITDA is straightforward, figuring out the "adjusted" number can be more a little more complex. This is because "adjustments" or "add-backs" are usually subjective and may vary from company to company. However, knowing the most common add-backs can help you better understand the process and ultimately, get the most value for your business.
What are Add Backs for Adjusted EBITDA?
Add-backs for Adjusted EBITDA are specific expenses or costs that are added back to the earnings before interest, taxes, depreciation, and amortization (EBITDA) of a company to present a more accurate picture of its operational profitability and cash flow. These adjustments are made to the standard EBITDA calculation to exclude non-recurring, one-time, or non-operational expenses that may distort the company's true economic performance. The purpose of these add-backs is to provide potential buyers, investors, or financial analysts with a clearer view of the business's earning potential by removing anomalies or expenses that are not expected to continue in the future.
Examples of common add-backs to consider:
Owner's Salary: Many founders pay themselves a salary that is higher than what they would pay another employee to do the same job. In this case, the excess amount can be added back to the EBITDA calculation.
Non-recurring Expenses: These are unlikely to occur again. Sometimes legal fees for a one-time lawsuit fall here or rare expenses for something like a natural disaster. (i.e. COVID-19)
Personal Expenses: Founders can sometimes mistakenly include personal expenses in their company's financial statements. These can be added back to the EBITDA calculation.
Rent Expenses: If a company owns the property it operates out of, the rent expense can be added back to EBITDA. This is because the expense of owning and operating the property is already included in the calculation.
Depreciation and Amortization: Although these expenses are typically included in the calculation, adjustments can be made if the company's assets are not being fully utilized or have been overstated.
Understanding the most common add-backs or adjustments to EBITDA is a bit more of an art than a science. Investment Bankers, Transaction Advisors, or even your CPA can offer some guidance around this. However, by having an idea of the most common add-backs as the seller yourself, you can better understand the process and ensure that you get the most value for your business when it comes time to sell.
