If you only remember one thing about add-backs, make it this: small shifts in āadjustedā expenses create big shifts in enterprise value. Add-backs are the bridge between messy, real-world financials and the EBITDA you underwrite. Get them right and you price risk accurately. Get them wrong and you pay tomorrow for profits that never show up.
Here are five questions that turn fuzzy add-backs into firm decisions, complete with what to ask for, how to sanity-check the math, and what to do when the answers arenāt clean.
Will this expense truly disappear under my ownership?
A classic seller narrative: āThose costs go away when I leave.ā Sometimes true. Oftenā¦optimistic.
Probe each add-back by asking: What replaces the function tied to this cost? If the owner is adding back an inflated salary, will you hire a GM at market rates? If āpersonalā travel or a vehicle is added back, is some portion actually business-use that youāll still incur? Your job is to translate story into run-rate reality. Request payroll records, org charts, and time responsibilities to confirm who does what and what it costs to replace. If you need to hire or pay market comp to keep coverage, that add-back shrinks or disappears.
Common pressure points:
- Owner compensation and perks. Validate the replacement cost, not just the subtracted cost.
- āNon-essentialā family employees. If youāll backfill the role to avoid a gap, itās not an add-back; itās a reclassification.
- Discretionary spend. Marketing or R&D āpulled backā to boost margins may need to return on Day 1 to protect revenue.
What to ask for: detailed payroll registers, job descriptions or responsibilities, and a roster of contractors/vendors tied to owner functions. Decision rule: treat every āseller-specificā cost as zero until youāve priced the replacement.
Is this āone-timeā expense actually recurring in disguise?
One-time legal bills, consulting projects, and relocation costs can be legitimate add-backs. But many āone-timeā itemsā¦happen every year. The test is pattern and cause.
Your question: What is the underlying driver, and is it likely to repeat? Scan three to five years of P&Ls for repeat categories (legal, IT clean-ups, facility fixes). A regulatory-exposed company with frequent small settlements probably faces ongoing expense risk; adding them back overstates earnings. Conversely, a genuine event (single ERP migration) is a cleaner add-back.
What to ask for: invoices, engagement letters, and general ledger detail for each claimed one-time item. Sanity check: if the same label shows up in multiple yearsāeven at different vendorsāitās not one-time.
Are we ignoring future spend or capex by āadding backā non-cash or deferred costs?
Depreciation is non-cash, until your forklift dies. Some sellers lean on ānon-cashā to inflate adjusted EBITDA while the asset base ages and maintenance/replace cycles loom. The same dynamic shows up in under-investment: cutting maintenance, marketing, or headcount to dress up numbers. Those āsavingsā walk back in the door under an owner who wants to protect revenue.
Your questions:
- What is the maintenance capex to keep revenue stable? (Not growth capex, maintenance.)
- Which expenses were cut that youāll reintroduce post-close? (Marketing, preventive maintenance, IT security.)
If the business requires ongoing reinvestment to sustain performance, pure add-back logic understates future cash needs. Treat high depreciation add-backs with caution if the asset base is old, and scrutinize āleanā years for deferred spend that will rebound.
What to ask for: fixed asset rollforwards, age of fleet/equipment, a three-year capex schedule, and vendor history for maintenance. Decision rule: if steady-state requires spend, normalize it in, donāt āadd it backā out of existence.
Do the add-backs reconcile to documentation and cash flows, and are they material?
Two parts here: evidence and importance.
Evidence. Donāt accept a bullet in a CIM. Tie each claim to source docs: payroll reports for comp, invoices and GL extract for expenses, contracts for canceled services. If a seller canāt substantiate an add-back with paper (or the timing/cash movement doesnāt tie to bank statements), treat it skeptically. A QoE process exists to adjudicate this, use it.
Importance. Not every $5k tweak deserves renegotiation airtime. Focus on adjustments that move valuation or structureābig owner comp gaps, recurring āone-timeā items, or anything that changes debt service coverage. The discipline is to triage: major add-backs get top billing; trivial noise gets left alone to conserve goodwill.
What to ask for: a seller-prepared add-back schedule with line-by-line support, plus a brief narrative for each item explaining why it wonāt recur. Decision rule: verify the top 80% of the dollar impact and use a QoE to validate the rest; bring material gaps to the table, not pebbles.
How do these add-backs change valuation, structure, and working capital?
Add-backs donāt live in a vacuum, they flow straight into price and terms.
Valuation math. If the seller touts $1.0M of EBITDA and your diligence supports $800k, a 4Ć deal just lost ~$800k of enterprise value. Thatās not āa rounding differenceā; thatās the heart of the purchase price. Build a quick sensitivity table showing valuation at various validated EBITDA levels and use it to drive a calm, math-first conversation with the seller and your lender.
Structure. If you and the seller canāt fully agree on add-backs, you can bridge with structure:
- Seller note for disputed, but plausible, adjustments, aligning incentives without pretending the cash earnings are higher than they are.
- Earnout tied to simple, auditable metrics (e.g., revenue or gross profit from named accounts) if āsavingsā are contingent on future behavior. Keep it capped and time-boxed.
- Escrow or special indemnity for specific, documentable risks uncovered in the add-back review.
Working capital. Aggressive add-backs sometimes hide cash-conversion strain (e.g., cutting collections support, deferring inventory buys). Your QoE work should feed a normalized working capital peg and true-up mechanics so you donāt fund yesterdayās receivables with tomorrowās equity.
What to ask for: a side-by-side of (a) sellerās adjusted EBITDA, (b) your validated adjusted EBITDA, and (c) valuation at agreed multiple(s); plus a draft WC peg calc using a trailing average. Decision rule: translate dollars into terms, donāt just disagree, re-engineer the deal.
Putting it together: a mini case
The claim. Seller shows $600k net income and $250k of add-backs, pitching $850k adjusted EBITDA. Add-backs include $120k owner salary āexcess,ā $40k āone-timeā legal, $30k marketing cuts, $60k depreciation.
Your review.
- Owner salary: replace with a $90k GM (not $0). Net add-back = $30k, not $120k.
- Legal: appears in three of the last four years due to recurring vendor disputes. Not one-time. Disallow $40k.
- Marketing: revenue dipped when spend fell. To sustain revenue, you plan to reinstate $25k. Disallow $25k.
- Depreciation: fleet average age = 10 years; maintenance capex runs ~$45k/yr historically. Treat a large portion as a cash reality. Reduce add-back by $45k.
Result. Validated add-backs: $250k ā ($90k disallowed + $45k capex proxy + $25k reinstated marketing + $40k recurring legal) = $50k. Adjusted EBITDA = $650k, not $850k.
At a 4Ć multiple, EV moves from $3.4M to $2.6M, an $800k swing. Use that delta to: (1) revise price, and/or (2) introduce a $300k seller note and a $200k earnout on gross profit retention, plus a working capital peg based on TTM averages. Then walk your lender through DSCR at the lower EBITDA to keep financing aligned.
Negotiating with facts, not feelings
The fastest way to turn an add-back debate into progress is to show your work. Sit down (virtually or in person) with a schedule that:
- Lists each add-back,
- Shows the sellerās rationale, your evidence, and the decision, and
- Quantifies the valuation impact at the agreed multiple.
Keep the tone cooperative: āWe still like the business. Hereās what our review supports and how we can bridge the gap with structure if needed.ā Sellers may push back; documentation and math keep the conversation grounded. And your capital stack will thank you for the clarity.
Red flags that warrant extra skepticism
- Adjusted EBITDA far above net income without clear reconciliation. (Whereās the cash?)
- Vague or undocumented add-backs the seller canāt substantiate with invoices, payroll, or contracts.
- Cuts to critical spend (marketing, maintenance) during sale prep that correlate with softening revenue.
- Commingled personal/business expenses that make cash tracing murky. If transparency is low now, it wonāt improve later.
When these pile up and the seller wonāt share risk (via price, note, or escrow), walk away. Discipline beats sunk-cost emotion.
Quick checklist (steal this)
- Map every add-back to a source doc (payroll, invoice, GL). No doc = no add-back.
- Price the replacement, not the removal (GM salary, contractor costs).
- Pattern-check āone-times.ā Scan 3ā5 years for repeats.
- Normalize maintenance capex and under-spend (marketing, maintenance, IT).
- Quantify the valuation delta and propose structure bridges (seller note, earnout, escrow) plus a working capital peg.
Final word
Add-backs are where the sellerās story meets your operating reality. Ask the five questions above, insist on evidence, and translate findings into price and structure, not conflict. Do that, and youāll stop paying for āadjustedā earnings that never show up and start buying businesses that perform the way your model expects. If you want a second set of eyes on a messy add-back schedule, or someone to turn your QoE into better terms, we do that every day.
Contact us todayĀ orĀ book a free consultationĀ and learn how we can be a trusted partner on your next deal!
