Selling Your Business? Don’t Sell Yourself Short – Enter the Arcane World of Add-Backs

Selling Your Business? Don’t Sell Yourself Short – Enter the Arcane World of Add-Backs

Business owners, particularly the small-shop variety, not uncommonly look upon their creations as they would a child.

The conceived it, nursed it along through difficult years, and finally guided their progeny to productive life. Just like one of their very own kids.

Yes, my firm is my child, they’ll tell you, yet with a not-so-familial bonus: when it grows up enough to achieve worthy stature, you can sell the sprog to a generous buyer with little emotion. And no one will judge you.

Do it right and we’ll even applaud you. My old friend Jo, who runs a travel agency, has been receiving the attention of suitors. Not the usual fellows, drawn by her whirlwind energy, insouciant languor, quick hilarity, power-drill urgency, and middle-aged punk-style hairdo. Jo’s an attractive package, but let’s keep it north of the neck, dear readers; our business today is selling a business.

A travel agency may seem archaic, like a radio repair shop or a tobacconist. Yet Jo always had a knack. Based in Washington, DC, she ran tours to Civil War battlefields with professors as guides before anyone else thought of it; wine tastings; rock climbing; spa holidays; she was right on the curve, kept her biz humming and fun.

Ten years back, she took a holiday to Thailand. I don’t think Jo saw much: while wandering in Chiang Mai, a hip destination, she spotted a biz-op, as she calls them.

In many nations, expats can live long term, but when visas run out, they must leave and come back. Sometimes it’s pro forma with nothing to do – you go; fly right back – Yanks can do that in Singapore, for example. Other times, you must apply at your host country’s consulate. My first ten years in Russia, that was the drill: every year, I’d go to Prague or Riga – fine destinations for a short visa holiday – visit the Russian consulate, cool my heels for a few days while the visa was readied, and then dash home to Moscow.

Jo noticed that guest houses and travel agents were offering visa renewal services to expats: a plane or bus ticket, a room in a welcoming city, passport pick-up for the consulate and so on. Jo said to herself, hmm.

The vacation went ‘cold storage’, she says. Jo figured if you combined the offerings of multiple hotels and agencies, you could advertise all on a single website, get better prices from bus lines and such, and make things easier for clients – that’s the main draw, you’re selling convenience.

Jo saw her chance to go international. She had the know-how, and how. Jo sold it, they bought it and once again, she was on the pioneer trail to a profitable business.

So now up jump the buyers. Travel took a pandemic hit, but wiseacres know it will bounce back. Jo’s firm is a good earner, has prospects for expansion in the right, monied hands. Jo would be happy to see her baby adopted; she wants that missed holiday, with more romantical suitors.

Jo called to catch up, but harbored a question: how do I value my company? I ran it down: most commonly, we use multiples of EBITDA or seller’s discretionary earnings, adjusted for add-backs. “There – add-backs. What the expletive is that?” – she wondered.

I told her this: with add-backs, you’re entering the realm of professional business appraisers.

As usual, I have friends covering the angles. Maud, partner in a high-profile law firm, provides the service to major companies globally. Brian, at a Midwest financial advisory, says helping midsize firms get sold is big business today. In Brooklyn, Dmitry the accountant, for a quite reasonable fee, will take your small business’s quarterly statements, stir them up and spit out monthly accounts – serious buyers demand monthlies – in a flash.

So, there’s plenty of hands to help. As always, you’ll still need to know the basics, so nobody can snow you. Let’s prep up.

Add-backs are costs, commonly inflated owner compensation and non-recurring expenses, that can be ‘added back’ to the company’s profit, thereby boosting the potential sale price. Buyers expect sellers to do this; indeed, Brian says neglecting to negotiate add-backs makes you look like a pigeon set for the pot. Playing tough earns respect, and that helps close the deal.

Owner’s compensation tops the list of add-backs. Owner-managers of successful companies tend to overcompensate themselves in salary, retirement benefits, health coverage and all manner of extra payouts. Most buyers plan to pay market for the seller’s replacement. The difference between the two levels of compensation forms an add-back to the selling price.

If the replacement will receive less compensation, they’ll also pay less tax. The difference between the two tax bills is yet another add-on for the seller, fully legit.

Lawsuit settlements and severance payments can be added back if they are truly one-offs. A company that regularly pays off legal claimants is hardly a good acquisition target. Yet one-offs like these hit every company sooner or later, so if their frequency isn’t worrying, the buyer needn’t beware. And the seller can add them to the sticker price.

Unique, non-recurring business expenses are standard add-backs. These include headhunter costs, terminated product offerings, legal and accounting costs for potential deals, and innumerable others – those skilled specialists can identify these items for you.

Personal expenses are sometimes paid by privately run companies. Dues for clubs and professional associations; the cost of the owner’s car (which may double-up for business and personal use); travel expenses unrelated to business (owners commonly bring spouses on business trips, stay over to enjoy the sights, then bill it all through the company, treating the expense as compensation). These costs are acceptable add-backs, too.

There possibilities are endless, but don’t get carried away. A common add-back is the expense of updating the company website. In principle, it’s legit, but some firms revamp their websites every two or three years – that’s hardly non-recurring. Even in these cases, a percentage might be added to the sale price, so consult that trusted expert to learn the acceptable formula.

The concept of add-backs is easy to grasp, once explained. But you shouldn’t go it alone: valuation experts must be consulted. There are too many pitfalls and packing a sale offer with aggressive – read greedy – add-backs can kill trust with your suitor.

That’s just what I told Jo, and she said: “Well, duh.” I met her in 1982 – she was 20 years old, and if memory fails not, that’s the first thing she said to me. I’d remarked, “Oh, you like Bauhaus,” after a review of her t-shirt… well, that’s me: ever alert and observant, always trying to help – as I hope you’ve all noticed.

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