Maximizing Business Value in a Sale: How EBITDA Addbacks Boost Your Valuation

EBITDA addbacks and pro forma adjustments could represent over 50% of the total value you could achieve through a sale transaction. According to a study by S&P Global that measured 600 broadly syndicated M&A and LBO transactions from 2015 to 2022, the average total addbacks as a percentage of reported last-12 months EBITDA at inception was 53%.

If you want to maximize value for your company through a sale process, it is essential to focus on EBITDA addbacks early in the process. Having detailed financial support and rationale for all the addbacks will help to ensure a smooth sale process, minimize last minute surprises and help you achieve the best possible outcome.

Table of Contents

1. The Case for EBITDA Addbacks

2. Standalone and Private Company Costs

3. One-Time and Non-Recurring Costs

4. Pro Forma EBITDA Adjustments

The Case for EBITDA Addbacks

Well documented addbacks, supported by detailed financials and clearly articulated rationale, help maximize value, ensure a smooth sale process, and prevent last minute surprises.

Maximize Valuation

One of the most important things a founder or CEO can do to maximize value in a sale transaction is to increase earnings before interest, taxes, depreciation and amortization (“EBITDA”). For many industries, EBITDA is a critical valuation benchmark for both strategic acquirers and private equity firms. Increasing EBITDA has a multiplier effect on valuation and ultimate sale price. For example, if a Company is acquired for 10x EBITDA, every incremental $1 million of EBITDA will result in an extra $10 million of value to the sellers. Increasing EBITDA could also increase the amount of debt a private equity firm can borrow during the financing of an acquisition, further increasing valuation and / or reducing the amount of equity needed to complete a transaction.

Highlight Growth and Cash Flow Potential

By identifying EBITDA addbacks, sellers can present a clearer picture of the company’s performance under normalized conditions - excluding standalone and private company costs, one-time and non-recurring expenses, and pro forma EBITDA adjustments. This allows buyers to better assess the business’s true earnings and growth potential, ultimately increasing valuation and attracting a broader group of prospective buyers.

Improve Credibility and Trust

Buyers are inherently skeptical during due diligence and scrutinize historic and projected financials.  Financials that contain false or misleading EBITDA addbacks increase buyers’ skepticism which in turn increases the level of due diligence they require and is likely to result in discounts to the financial projections and the buyer’s ultimate valuation.  Clearly presented financials on the other hand, establish credibility and foster trust in a seller.

Smooth the Due Diligence Process

If EBITDA addbacks are carefully documented before the sale process begins, it reduces the time and friction involved during the due diligence process. Buyers and their M&A advisors will spend less time questioning the EBITDA addbacks if the rationale behind each addback is well-supported, making the overall due diligence process more efficient and increasing the likelihood of a successful close.

Minimize Last-Minute Surprises

If EBITDA addbacks are not clearly explained or they are not supported with financial detail buyers may seek to negotiate down the purchase price or, worse, walk away from a transaction. Early identification and validation of EBITDA addbacks prevent last-minute disagreements that could derail the sale.

Top 3 Categories of  EBITDA adjustments:

1. Standalone and Private Company Costs

2. One-Time or Non-Recurring Costs

3. Pro Forma EBITDA Adjustments

Standalone and Private Company Costs

Standalone and private company costs are expenses that are incurred under the current ownership structure that would not continue under new ownership. They may include expenses such as an owner’s salary or excess perks. These costs can be dependent on specific buyers - for example, a private equity firm acquiring your business as a new platform company would still need a CEO and CFO to run the business, but a strategic buyer acquiring the company may not. Below are some common standalone and private company costs:

Owner’s Salary and Compensation Adjustments

• Above-Market Salary: If the owner takes a salary above market rate, the difference between this and a standard salary for the role may be an acceptable addback.

• Family Member Salaries: In some private companies, family members may be on the payroll without having a direct, proportional impact on operations. Adjusting these salaries or removing them entirely may be appropriate.

• Discretionary Bonuses: One-time or irregular bonuses paid to the owner or family members can also be added back if they are unlikely to continue under new ownership.

Personal Expenses Run Through the Business

• Travel and Entertainment: Business owners might charge personal travel, entertainment, or meals to the company. These expenses may not be permitted under new ownership

• Personal Vehicles: Costs for personal vehicles, fuel, or maintenance that are not directly related to business operations are common EBITDA addbacks.

• Lifestyle Expenses: These could include items such as club memberships, tickets to events, or even luxury accommodations that were charged to the business but don’t serve a business purpose.

Owner-Specific Perks and Benefits

• Health Insurance and Retirement Plans: Owners might have customized benefits or retirement contributions that exceed what would be necessary or typical for an executive in the same role.

• Life Insurance for Owner or Family Members: If life insurance policies are in place to benefit family members rather than as key-person insurance, this can often be added back.

• Insurance Premiums: Life or other insurance policies that specifically benefit the owner or family members rather than employees can often be added back

Related-Party Transactions

• Rental Payments to Family-Owned Properties: Many family businesses rent real estate from the owner or a family entity, often at above-market rates. The difference between the actual and market rate can be adjusted.

Discretionary Donations / Marketing Costs

• Event Sponsorship: Family-owned businesses sometimes sponsor local events, clubs, or charities in the owner’s name rather than purely for business benefit. These can be EBITDA addbacks if they don’t directly impact revenue.

GAAP Adjustments

• Accounting Adjustments: To the extent necessary, buyers will adjust the company’s financials to align them with Generally Accepted Accounting Principals (GAAP). This can result in changes in revenue recognition, lease accounting adjustments, accrual-accounting adjustments, capitalization of internally developed software expenses, among others.

One-Time or Non-Recurring Costs

“One-time and non-recurring costs are expenses that would not be incurred during the normal course of business. These expenses distort a company’s historical operating expenses and understate reported EBITDA. ”

One-time and non-recurring costs are not indicative of the future EBITDA of the Company and buyers will often agree to exclude them in performing their valuation.

Common one-time and non-recurring cost EBITDA add backs:

Legal Settlements or One-Time Legal Fees

• These could include settlements or specific legal issues that are not recurring in nature. For example, a settlement related to an employee termination or a contract dispute with a vendor could qualify as one-time and non-recurring in nature. The legal fees related to these types of actions are also EBITDA addbacks

Relocation or Build-Out Costs

• One-time costs associated with moving to a new facility or a renovation that will not be ongoing expenses could qualify. In addition, investments in the buildout of a new product or division could be considered one-time expenses if these are unusual and non-recurring in nature.

One-Time Professional Fees

• These could include consulting, legal, or accounting fees for services tied to unique events such as restructuring, litigation, new business start-up, tax planning, or regulatory, that will not recur.

Severance Costs

• Severance costs incurred in connection with a one-time reduction in force (RIF) or the termination of a long-time executive could be classified as one-time or non-recurring costs.

Inventory Write-Offs / Write-Downs

• Inventory write-offs related to product recalls or obsolescence as well as write-downs related to a reduction in the value of the inventory on hand can be one-time or non-recurring in nature and eligible for an EBITDA addback.

One-Time Investment in Technology or Equipment

• Significant, non-recurring investments made to upgrade technology or equipment, may qualify as an addback. Some technology investments may also be capitalized under GAAP.

Transaction Related Costs

• All costs related to the sale transaction, including preparation, are likely EBITDA addbacks. These costs can include advisor costs, consulting costs, accounting costs, legal costs, and may also include allocated employee costs.

• Costs related to financing transactions are also likely to qualify as one-time or non-recurring costs. These costs could include advisor costs, legal costs, upfront fees to banks, among others.

Pro Forma Adjustments

“Pro forma adjustments are adjustments to historical results that reflect changes that have been made to the business, or are expected to be made to the business.”

Pro forma adjustments demonstrate what the financials would look like if those changes had been made at the beginning of the historical period in question. For example, if a company completed significant cost savings initiatives on July 1st, the pro forma adjustments would assume those adjustments were made on January 1st and would reflect the full year benefit from the cost savings initiatives.

Common pro forma adjustments include:

New Business / Product Launch

• A new business line or product that was launched in the second quarter could be a full year pro forma adjustment. This adjustment would involve annualizing the full year revenue, gross profit and operating expense impact of the new business or product launch. Typically this kind of adjustment would require determining the run-rate annual impact of the new business or product and calculating the incremental changes on the financial statements. Only the incremental changes would be included in the pro forma adjustment.

Cost Savings Initiatives or Compensation Rates

• Changes in operating expenses that result from headcount changes or changes to compensation rates can result in pro forma adjustments. A buyer will evaluate whether the changes are sustainable and market-based or whether they were completed to provide a short-term benefit to the financial performance. If the cost savings initiatives or changes in compensation rates are sustainable,the full year impact of these changes can be added back as a pro forma adjustment to EBITDA.

New Customer Additions or Losses

• A significant new customer acquisition or the loss of a major customer could be a pro forma adjustment to EBITDA. Sellers will evaluate changes in major customers to identify any changes that could reduce future revenue and EBITDA. In order to calculate the pro forma adjustment, a buyer will evaluate the net incremental change in revenue, gross profit and operating expenses for the period.

Sale or Closure of a Business Line or Product

• If a business line is sold or a business line or product line is terminated, all revenues and expenses related to discontinued operations would be removed from EBITDA because these activities will not continue post-close. If the discontinued operations cause an operating loss, it would increase pro forma EBITDA.

Changes in Supplier Agreements

• If a company negotiates new terms with a supplier that results in lower costs, a seller could make a case for a pro forma adjustment for a full year benefit from the more favorable costs. Depending on how much inventory exists and the company’s inventory valuation method these adjustments can be challenging to document. 

Questions? Contact Keene Advisors to learn how we can help you drive a successful sale process, identify EBITDA addbacks, and maximize value for your business. Follow us on LinkedIn to receive additional updates on M&A, capital raising and strategy related content.   

Conclusion

By identifying these common EBITDA addbacks, company owners can present a more accurate picture of the business’s true earning potential under new ownership conditions. Each EBITDA addback should be well-documented and justifiable to ensure that prospective buyers view them as credible adjustments, leading to a smoother due diligence process, fewer last minute surprises, and a potentially higher valuation.

About Keene Advisors

Keene Advisors, a Benefit Corporation, is a full-service Boston-based strategy consulting and investment banking advisory firm with over $40 billion in successful mergers and acquisitions, leveraged buyouts, capital raising, and restructuring advisory transactions.

Case Study

Confidential Family-Owned Business Client

• Keene’s team was engaged to prepare family executives for a sale process.

• The engagement started a year before the contemplated sale transaction. Keene’s team helped to professionalize the finance, accounting, and FP&A functions, including by developing KPIs, assisting in the completion of an audit, identifying EBITDA add-backs, developing pro forma adjusted financial statements, developing a long-term financial plan and model, and leading the preparation of an electronic dataroom.

• As part of the process, Keene’s team identified a total of $6.6 million in standalone and private company costs, one-time and non-recurring expenses and pro forma adjustments to EBITDA.

• The business was sold to a private equity firm for over 13x EBITDA, implying that over $86 million of incremental value resulted from the work performed by Keene’s team prior to the launch of the sale process.

FAQs

• How long does it take to prepare to sell a business?

  It is never too early to start preparing for a sale process, however it typically takes 3-6 months for companies that have never been through the process before. The earlier you begin preparation, the more time you will have to make adjustments to the business and to the financial trajectory that can have a significant impact on the final valuation.

• How do I identify EBITDA addbacks?

  Follow this guide to identify common addbacks. Hire an experienced financial advisor like Keene Advisors to help you navigate the process and ensure you are not leaving value on the table. You may also consider hiring a large accounting firm to assist you in preparing a Quality of Earnings report that you can present to prospective buyers. Buyers are likely to conduct their own Quality of Earnings analysis but this can ensure that you are not missing any valuable EBITDA addbacks.

• How do EBITDA addbacks increase the value of my company?

  EBITDA is commonly used by buyers and financing providers (banks, private credit providers, etc.) as an important benchmark for valuation and leverage availability.  Addbacks to EBITDA are a common way to express the true or underlying EBITDA generating capability of your business.

Disclaimer: This commentary is intended for general informational purposes only. Keene Advisors does not render or offer to render personalized financial, investment, tax, legal or accounting advice through this report. The information provided herein is not directed at any investor or category of investors and is provided solely as general information. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action. Keene Advisors does not provide securities related services or recommendations to retail investors. Nothing in this report should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.