You’ve decided to sell your business and are very excited about it. You have put years of effort into building your empire, and now you see the light at the end. You want to power through, close the deal, and ride off into the sunset.
You shouldn’t rush. Although it may be attractive to jump at the chance of selling, not correctly calculating the seller’s discretionary income (SDE) can result in a loss of thousands, or even hundreds of millions of dollars. SDE is the sum of net earnings plus addbacks. Most likely, your business will be sold in multiples. While most people are familiar with the first number, the secret to lucrative exits is the second number.
Owner benefits and non-recurring costs are called add-backs. They are listed on your current financial statements. However, they will not be carried forward when a new owner takes over. It is crucial to find them and then add them back below your net income in your exported P&L. This will allow you to charge top dollar for the business.
I’ve seen thousands of owners sell their online businesses over the years. Not accounting for add-backs when valuing a company is one of my biggest mistakes. In my book The EXITpreneur’s Playbook: How To Sell Your Online Business For Top Dollar By Reverse Engineering Your Pathway To Success, I detail with plenty of numbers, and examples of why ignoring or rushing through add-backs could cost you the equivalent of your child’s college education. Here’s a breakdown of addbacks and the three most important levels for entrepreneurs.
How add-backs work
These add-backs can describe as owner benefits or non-recurring expenses. They do not carry forward to your buyer when you take over your business. You can show your buyer that your company’s fees are likely to be lower if they buy it. While these details may seem more complex than usual, they will allow you to build trust and rapport with your potential buyer during the negotiation process.
Some add-backs can be noticeable. Owner-operators businesses have “owner benefits,” which are added-backs if the owner receives a large salary or company coverage for your health insurance. Other add-backs may be more complex and include converted points, cash-back on credit cards, or money that converts to dollars. It ultimately depends upon the structure and setup of your business. There are no two deals ever the same.
It’s essential to be both discerning and rigorous with add-backs. A lack of diligence can leave money on the table. But too much nickel-and dinging or poor math can damage your relationship and possibly cause a deal to fail. As you prepare to sale your business, there are three things you need to remember.
Add in any potential add-backs
Owners get a few perks from owning their businesses. These can be classified as add-backs. Owner payroll, owner health insurance, and owner retirement contributions are the most apparent add-backs.
Although these add-backs seem obvious, owners make common mistakes that put them in difficult situations when negotiating a deal. When it comes to the owner’s salary, this figure assumes a 40-hour workweek. Do you work 40 hours a week? If your response is yes, it’s time for your buyer to negotiate. They’ll point out that there will be more than one person needed to take over the business. This can lead to higher projected operating costs and an adjusted deal after due diligence.
Giving charitable donations can also be a problematic add-back. The next owner of the company doesn’t have an obligation to make philanthropic contributions. But what if charitable efforts for your company are tied to how the product’s marketing and sales? While charitable donations are an option, they should only be added-backs that don’t impact your total sales. You need data and a long-term plan.
To get more add-backs, make a list of all one-time expenditures from the previous year.
Your company’s past 12 months of financial statements are used to calculate your seller discretionary earnings. If they don’t carry forward, these expenses can be added back to your valuation and counted as one-time expenses.
These are also add-backs if your business has to cover one-time legal costs or file for new trademarks. You can purchase equipment or new graphic designs once only. These are also add-backs. You can’t get the most value from your business if your accounting is in disarray. You can hire an eCommerce accountant to do back bookkeeping for two to three years. These one-off expenses could also count as add-backs.
Your expenses that are not included in your P&L may be added-backs. However, it would help if you were careful. Are you using the business meals that you are expensing for business purposes? Your buyer will examine every line in your financial statements. Adjust your financial spending accordingly so your numbers are transparent.
It would support if you dug deep to find the best places and leave no stone unturned.
Although add-backs in this final category can be very specific, it is essential to keep the property’s value as high as possible.
For example, let’s say you have expenses that happen not every year but every few years. An example of this is a website redesign and a brand refresh. Although you may spend $10,000 on this project, it is something that you will only do every 2-3 years. It is not a recurring expense, so the bulk of it can be considered an addition.
Another prominent example with entrepreneurial owners is professional development expenses, such as courses, masterminds, or business coaching. To make themselves a better entrepreneur, the seller decided to invest in these resources. The buyer can also choose to invest in these resources for their personal use. It’s an investment that isn’t necessary for the business and could count as an additional expense.
The most rewarding part of your entrepreneurial career can be selling your business. You need to make sure you have everything in place to be successful. Trusted advisors can help you. Think less entrepreneurially and more like an EXITpreneur, and you might be closer to a large cashout than you thought.