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EBITDA add backs explained

See all articlesEBITDA
Corporate advisory
By
Tom King
Tom King
Senior Analyst
January 11, 2023
6
minute read

Introduction to EBITDA

EBITDA is a common measure of a company’s profitability that excludes certain expenses such as interest, taxes, depreciation, and amortization. These expenses are considered non-operating expenses and are not directly related to the company’s core business operations. By excluding these expenses, EBITDA provides a rough (albeit imperfect) measure of a company’s ability to generate cash.

Consequently, EBITDA is a widely used metric to determine a company’s valuation (learn more about multiples approach to valuing a business). By removing the effects of accounting and financing decisions, EBITDA is a standardised measure of profitability, allowing buyers and investors to compare a business to its peers on a like-for-like basis.

What are EBITDA add backs?

Given its role in determining business value, the EBITDA figure presented to buyers during a sale process needs to reflect the “true” earnings of the business.

To achieve this, corporate advisors will make a series of EBITDA “add backs”, removing (or adding) expenses to create an accurate view of the business’ historical and future profitability.

EBITDA add backs can be positive or negative.

Positive add backs

Positive add backs remove costs from the business and in turn, increase EBITDA. These add backs broadly fall into two main categories:

1. One-time expenses:

These are expenses that are not expected to recur in the future, such as legal fees or restructuring costs.

2. Personal expenses:

These relate to the personal expenses of Founder(s) that are paid by the business, such as motor vehicle costs and overseas travel. Personal expenses are often run through a business to reduce tax liability.

Some recent examples of positive EBITDA add backs performed by Nash include:

  • Litigation expenses relating to a historical legal liability
  • Bonuses paid to shareholders serving as dividends
  • Goodwill impairments
  • Losses on infrequent foreign exchange transactions
  • Inclusion of income historically collected “off the books” as cash
  • Registration, insurance, maintenance and fuel costs relating to personal motor vehicles

Negative add backs

While some corporate advisors are renowned for artificially inflating a company’s EBITDA through add backs, it is important to note that add backs can also be negative. After all, the intention of add backs is to state the “true” earnings of the business.

Nash Advisory will identify negative add backs before a business is taken to market. Pro-actively volunteering these negative add backs has several advantages:

1.       Builds trust with the buyer

2.       Reduces the risk of a buyer applying a discount to their valuation at the NBIO stage

3.       Limits the buyer’s ability to re-negotiate their offer during diligence.

Negative add backs typically fall into two main categories:

1. Related party expenses:

These are expenses that are waived or paid at a significant discount due to the recipient being a related party, such as not paying the Founding CEO a salary and below market rent paid for use of a premises owned by a Parent Company.

2. Non-operating income:

These are extraordinary gains from non-operating activities, such as the sale of assets and insurance recoveries.

Some recent examples of negative EBITDA add backs applied by Nash include:

  • Removing income received from a large, one-off foreign exchange gain
  • Adding wage expense, bridging the difference between the Founding CEO’s salary and the “market rate” for a CEO with similar skill and experience
  • Removing income received from a large, one-off insurance recovery
  • Adding rent expense for a property used by the business and owned by the Founder’s family trust

How add backs can increase sale value

Nash Advisory is highly experienced in identifying potential add backs for your business. As part of the sale ready process, our expert team will deep dive into your financials, identifying all add backs to reduce deal risk and maximise your business sale value.

In the below example, add backs increased the sale value of the business by $9,000,000.

Original Management EBITDA = $8.6m
Plus add backs:
EBITDA after add backs = $9.8m

EBITDA multiple = 7.5x

Valuation before add backs = 7.5 x $8.6m = $64.5m

Valuation after add backs = 7.5 x $9.8m = $73.5m

Value created for Shareholders = $9.0m

While the above example shows how add backs can increase business value significantly, the intention of any add back process is to present a “fair and accurate” view of a Company’s underlying profitability.

Add backs become a key focus area in due diligence and it is not uncommon for a buyer to interrogate individual invoices relating to each add back. Given their impact on sale value, it is important to engage an experienced advisor that carefully reviews and understands your accounts to ensure all add backs are accepted by a buyer.

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