Adjusted EBITDA: Which Addbacks Will Buyers Accept?

Most private companies are valued on a multiple of EBITDA, and the EBITDA in question is rarely the figure in the statutory accounts. Owners and their advisers adjust it to show what the business earns under normal ownership. These adjustments, usually called addbacks, are where the first serious argument with a buyer tends to start.

Every euro of adjusted EBITDA is multiplied. At a multiple of six, an addback of €100,000 is worth €600,000 of price, and losing it in due diligence costs the same amount. This guide looks at which normalisation adjustments buyers usually accept, which they challenge and what evidence makes the difference.

What an addback is

Adjusted EBITDA starts from reported EBITDA and removes items that do not reflect the ongoing business. The test is easy to state: would a new owner still incur this cost, or still earn this income, after the sale? If not, the item can be adjusted.

Adjustments work in both directions. Some increase EBITDA, such as a one-off legal settlement. Others reduce it, such as an owner who takes a salary far below market or a company that rents premises from the family at a discount. Buyers will find the negative ones on their own, so a seller who presents them first gains credibility for the rest of the list.

Addbacks buyers usually accept

When they are documented, these adjustments are rarely controversial:

• Genuine one-off costs. A lawsuit that has been settled, a flood repair only partly covered by insurance, or the cost of a one-time restructuring.
• Owner salary normalised to market. The difference between what the owner takes and what a hired manager doing the same job would cost, including social charges and bonus.
• Family members on payroll. Salaries paid to relatives who do not work in the business, or who are paid well above the rate for their role.
• Personal expenses through the company. Private cars, travel, housing or school fees booked as business costs.
• Related-party rent at market. If the company rents premises from the owner, the rent is restated to an independent valuation, up or down.
• Non-recurring legal and consulting fees. Fees for a specific project that has ended, including the costs of the sale process itself.

Addbacks buyers usually challenge

Other items meet resistance, and some are rejected almost automatically:

• Recurring "one-off" costs. If consulting, recruitment or restructuring fees appear every year under a new name, buyers treat them as a normal cost of running the business.
• Pro forma savings that have not happened. Cost cuts that are planned but not yet implemented belong in the buyer's model, not in the seller's EBITDA. Savings that are already in place but visible for only part of the year can be annualised, with evidence.
• Owner salary benchmarked too low. If the owner runs sales, holds the key client relationships and approves every quote, replacing that person will cost more than a general manager's salary, and buyers will benchmark the actual role.
• Costs the business needs to keep running. Adding back underspent maintenance, deferred marketing or the salary of a key position left vacant only shifts a cost the buyer will have to pay.

Disputed owner expenses sit in between. A car used partly for business, a club membership that brings in clients or a spouse who does some of the bookkeeping are all arguable. Here the outcome depends on the evidence and on how reasonable the claimed amount looks.

The evidence buyers expect

An addback without support is only an assertion. For each adjustment, prepare:

• Invoices and ledger entries that show the exact amount and the period in which it was booked.
• Contracts and settlement agreements for legal matters, leases and consulting projects, showing that they have ended.
• Board minutes or shareholder resolutions that record one-off decisions such as a restructuring or the end of a project.
• Payroll data for the owner and family members, together with a market benchmark from a salary survey or a recruiter.
• A rent valuation from an independent surveyor for any premises owned by the owner or the family.

Many sellers now commission a sell-side quality of earnings review (QoE) from an accounting firm before going to market. It tests each adjustment the way the buyer's advisers will, and gives buyers a single reconciled figure to start from.

A worked example

Take a hypothetical company with reported EBITDA of €1.2 million. The owner's first draft lists these adjustments:

• Owner salary of €250,000 against a market rate of €170,000: +€80,000
• Spouse on payroll with no role in the business: +€45,000
• Personal car and travel: +€25,000
• Settled lawsuit: +€110,000
• Rent paid to the owner's property company, €60,000 below market: -€60,000
• Consulting fees, booked as one-off for the third year running: +€80,000
• Planned savings from moving the warehouse next year: +€120,000

The draft shows adjusted EBITDA of €1.6 million. The buyer accepts the first five lines, which are supported by payroll records, invoices, a settlement agreement and a rent valuation. It rejects the consulting fees as recurring and the warehouse savings as not yet achieved. The agreed adjusted EBITDA is €1.4 million.

The gap is €0.2 million of EBITDA. At a multiple of six, that is €1.2 million of price, decided by documents rather than by negotiating skill.

Checklist before you go to market

1. List every adjustment for at least the last two or three years, positive and negative.
2. Tie each one to the ledger and to a source document.
3. Remove recurring items from the list before a buyer does it for you.
4. Benchmark the owner's actual role, not the job title, and get a market rent valuation.
5. Stop running personal costs through the company at least a year before the sale, so the cleaner figures show in the accounts.
6. Consider a sell-side QoE if the adjustments are large or numerous.

The bottom line

Adjusted EBITDA is a negotiating position until each addback is backed by evidence. A shorter list that survives due diligence is worth more than a long one that the buyer strikes out line by line, and it keeps the discussion about price rather than about credibility.

At Conclave Partners we help owners of mid-sized companies prepare for a sale and negotiate the terms behind the headline price, working on a success fee basis. If you are thinking about selling in the next few years, reviewing your adjustments with us early is a good place to start.

Related reading: Five Things to Fix in Your Accounts Before Buyers Look

Sergi Kosiakof, Conclave Partners

This article is general information, not financial, legal or tax advice. The example is illustrative. Always take advice for your specific situation.