Add-backs: how a $174,000 business gets advertised at $240,000

What an add-back is

An add-back is an expense the seller adds back to profit, on the argument that it will not continue under new ownership.

The logic is sound. If the owner pays themselves $80,000 and you will pay yourself nothing because you are taking a loan instead, that $80,000 really is available to you. Adding it back gives a truer picture of what the business produces.

The trouble is that nobody audits the list.

The three tiers

Tier one: uncontroversial. Owner's salary and payroll taxes. Depreciation and amortization. Interest on debt that does not transfer. These appear on the tax return, they are easy to verify, and nobody disputes them.

Tier two: legitimate but requires proof. Personal travel, meals, vehicle, health insurance, a family phone plan. All genuinely discretionary in principle. All impossible to verify without documents — and it is remarkable how often the documents do not exist.

Tier three: not really add-backs. A family member's salary for real work. A recurring "consulting fee" to a related entity. Deferred maintenance. Below-market related-party rent. A one-time cost that recurs annually.

Most of the gap between advertised and documented earnings lives in tiers two and three.

The two tests

For each add-back, in order:

Test one — can you show me?

Not an explanation. A document. An invoice, a mileage log, a credit card statement, a line on a tax return. If it cannot be pointed at, it does not count. This is not scepticism about honesty; it is the same standard a lender applies, and a bank will not fund an add-back it cannot see either.

Test two — will it actually stop?

Would a competent new owner genuinely not incur this cost? Three sub-questions expose most of the failures:

• Does it recur? Check three years. An expense in all three is structural.
• Does someone do work for it? If yes, that work continues, so the cost continues.
• Does the business need the thing? A delivery vehicle in a delivery business is not a perk.

The worked example

A listing advertises $240,000 of SDE. The add-back schedule reads:

Supported: $68,000. Unsupported: $65,800.

Documented SDE is $174,200, not $240,000. At a 2.25× category midpoint, that is roughly $148,000 of difference in what the business is worth — from one column of a spreadsheet nobody had checked.

What to do about it

Do not accuse anybody of anything. Most sellers building an add-back schedule are being optimistic, not dishonest. The right posture is a request for documents, not an allegation.

Price on what is documented. This is not a negotiating tactic, it is the only defensible basis. And say so plainly: "We priced on the add-backs we can see. Show us the rest and the price moves."

Offer an earn-out for the difference. If the seller genuinely believes the full $240,000, an earn-out costs them nothing — they get the money when the figure proves out. If they refuse, you have learned something important without an argument.

Watch the owner-labour question separately. It is not technically an add-back problem, but it is the same failure of realism. If payroll runs at 8% of revenue in a category where 15% is normal, the difference is the owner's unpaid hours, and replacing them is a real cost you inherit on day one.

The one number to hold on to

After all of it, the question is simple: what does this business earn for someone who runs it the way it will actually be run?

Not the way it was run by someone whose spouse worked unpaid and who took no holiday for six years. The way you will run it, paying market wages for the work that gets done.

That number is what you are buying. Everything else is presentation.