As a business owner looking to sell your business, you're likely aware of the concept of "add backs." Add backs, also known as adjustments, are financial adjustments made to your business's financial statements to reflect the true earnings potential of the business. These adjustments are crucial for accurately valuing your business and presenting it in the best light to potential buyers. In this article, we'll delve into the best ways to include add backs in your business before selling, ensuring that you're able to showcase its true value.
Understanding Add Backs
When valuing a business, potential buyers are interested in its profitability. However, the financial statements might not always accurately reflect the true earnings potential due to various reasons such as non-recurring expenses, owner perks, or extraordinary items. Add backs involve adjusting the financials to show a more accurate representation of the business's actual earnings.
Identifying Add Backs
Start by identifying expenses that are specific to the current owner or are one-time occurrences. These might include excessive owner salaries, personal expenses charged to the business, or non-essential expenses that won't be incurred by new owners.
Categorizing Add Backs
Categorize add backs into different groups such as owner-related expenses, non-operating expenses, and one-time events. This categorization helps potential buyers better understand the nature of adjustments and evaluate their impact on future earnings.
Documenting Add Backs
Thorough documentation is crucial. Keep a record of each add back, explaining its purpose and the rationale behind it. This documentation not only helps in valuing the business but also builds trust with potential buyers.
Gather supporting documents for each add back. This might include contracts, receipts, and financial statements. The more evidence you provide, the more confident buyers will be in the accuracy of your adjustments.
Professional Financial Help
Consider working with an experienced accountant or financial advisor, which Exit Stage Left Advisors can recommend to you. Their expertise can be invaluable in identifying, calculating, and presenting add backs in a credible manner.
Honesty And Transparency
While add backs can enhance the perceived value of your business, it's important to maintain honesty and transparency throughout the process. Misleading potential buyers could lead to trust issues later in the negotiation process.
Presenting Add Backs To Buyers
When presenting your business to potential buyers, we will clearly outline the add backs and their impact on the business's profitability. Present the adjusted financial statements alongside the original ones for a comprehensive comparison.
Negotiating With Buyers
Be prepared for potential buyers to question or challenge your add backs. Be open to discussion, provide the necessary documentation, and justify each adjustment.
Importance Of Clear Communication
During negotiations, maintain clear communication regarding the add backs. Address any concerns or questions promptly and ensure that the buyer understands the reasoning behind each adjustment.
Potential Buyer Concerns
Buyers might worry that add backs are an attempt to manipulate the business's valuation. Address these concerns by being transparent about the methodology used to determine each adjustment.
Common Add Backs Examples
Some common examples of add backs include excess owner salaries, discretionary expenses, non-recurring legal fees, and one-time marketing campaigns.
Preparing For Due Diligence
As the due diligence process begins, be ready to provide comprehensive documentation and explanations for each add back. This will help potential buyers feel confident in their decision.
Finalizing The Sale
Once a buyer is satisfied with the add backs and the overall valuation, you're closer to finalizing the sale. Ensure that all agreed-upon adjustments are properly documented in the sales agreement.
What are add backs in business valuations?
Add backs are adjustments made to a business's financial statements to accurately reflect its true earnings potential by removing owner-specific or one-time expenses.
How do I identify add backs in my business?
Identify add backs by analyzing expenses that are not essential to the business's operations or are specific to the current owner's situation.
Are add backs legal during a business sale?
Yes, add backs are legal and common in business sales as long as they are accurately documented and transparently presented to potential buyers.
Can add backs be challenged by potential buyers?
Yes, buyers might question or challenge add backs. Providing detailed documentation and explanations can help address their concerns.
Should I work with a professional to determine add backs?
Working with a professional accountant or financial advisor can enhance the credibility of your add backs and the overall business valuation.