// THE DEAL DESK
Add-Back
An expense a seller removes from historical EBITDA on the grounds that it does not reflect the ongoing economics of the business — owner compensation above market, a one-time legal settlement, rent paid to a related party.
Purchase price is a multiple of adjusted EBITDA, so an add-back does not enter a deal at face value. It enters at the multiple. At 8x, a $500,000 add-back that fails post-close scrutiny is a $4 million equity mistake.
An add-back is a claim about the future, filed as a statement about the past.
// THE TAXONOMY
The seven places EBITDA gets manufactured
Every add-back bridge draws from the same seven categories. None is illegitimate. All seven are gameable.
- 01
Owner compensation normalization
The founder paid themselves $850K; a market-rate CEO costs $400K; the seller adds back $450K. Fair in principle. The question is who actually does the work — if the founder also runs sales, the normalization is $450K minus the cost of the person you now have to hire.
- 02
Non-recurring items
The most abused category, because recurrence is a judgment call rather than an accounting fact. A legal settlement in FY24 is non-recurring. A legal settlement in FY22, FY23 and FY24 is a cost of doing business in that industry, relabelled.
- 03
Run-rate adjustments
A strong partial period annualized — a contract signed in month nine, extrapolated across twelve. The add-back most sensitive to period selection, and period selection is the seller’s choice.
- 04
Pro-forma cost savings
Savings identified but not realized. These are not earnings. They are your value-creation plan, and the seller is charging you a multiple to buy back your own thesis.
- 05
Related-party transactions
Rent paid to a property entity the seller owns, at a rate the seller set. Normalizing to market is correct — verify the market rate independently, because the seller chose both sides of that transaction.
- 06
Discontinued operations
Clean when the operation is genuinely severed. Less clean when the discontinued line shared a salesforce, a warehouse or an ERP licence with the business you are buying — costs that do not discontinue when the revenue does.
- 07
Personal expenses run through the business
Vehicles, travel, family on payroll. Usually the smallest line and the easiest to verify, which is why it is often presented in the most detail. Volume of documentation is not the same as materiality.
// HOW TO TEST IT
Three properties, all at once
A defensible add-back holds all three. Not two.
- It is traceable.
- You can follow it to specific general-ledger entries, not to a summary schedule the seller’s advisor prepared. A schedule is an assertion. The ledger is the record.
- It is non-recurring across the full look-back, not the selected one.
- Ask for the same category across every period available. Recurrence is only visible on a long enough window, and the window is the seller’s most powerful lever.
- The counterfactual holds.
- If the cost disappears, does the business still work? Remove the founder’s above-market compensation and you must add back the cost of replacing what the founder actually did.
An add-back failing one of the three is not fraud. It is usually optimism nobody has been asked to defend. But it belongs on a challenge list before exclusivity, not in a quality-of-earnings draft that lands with three weeks left on the clock.
The full argument, including the multiplier arithmetic and why the sequencing is backwards, is in The EBITDA Illusion.
// QUESTIONS
Common questions
- What is an EBITDA add-back?
- An add-back is an expense a seller removes from historical EBITDA on the grounds that it does not reflect the ongoing economics of the business — owner compensation above market, a one-time legal settlement, rent paid to a related party. Add-backs are legitimate in principle. Every add-back is also a claim about the future filed as a statement about the past: the seller asserts that a cost which did occur will not recur.
- What are the seven categories of EBITDA add-back?
- Owner compensation normalization, non-recurring items, run-rate adjustments, pro-forma cost savings, related-party transactions, discontinued operations, and personal expenses run through the business. None of the seven is illegitimate. All seven are gameable, and non-recurring items are the most abused because recurrence is a judgment call rather than an accounting fact.
- How do you test whether an add-back is defensible?
- A defensible add-back holds three properties at once. It is traceable to specific general-ledger entries rather than a summary schedule prepared by a sell-side advisor. It is non-recurring across the full look-back period rather than the window the seller selected. And the counterfactual holds — if the cost disappears, the business still functions, which means removing above-market owner compensation requires adding back the cost of replacing what the owner did.
- How much does an unsupported add-back cost a buyer?
- Purchase price is a multiple of adjusted EBITDA, so an add-back enters the deal at the multiple rather than at face value. At 8x, a $500,000 add-back that fails post-close scrutiny is a $4 million equity mistake. On a lower-middle-market platform at $40M enterprise value that is ten percent of the deal, and it is equity rather than debt.
// VERIFY BEFORE YOU BUY