Understanding Legitimate Add-Backs in M&A Transactions

Understanding Legitimate Add-Backs in M&A Transactions
A practical guide for buyers and sellers navigating EBITDA adjustments in mergers and acquisitions.
Good Hope Advisors
What Are Add-Backs?
In mergers and acquisitions, add-backs are adjustments made to a company's financials — typically to its EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) — to highlight expenses deemed non-recurring, unnecessary, or specific to the current ownership.
These are expenses that, theoretically, will no longer exist under new ownership. Sellers use add-backs to showcase an "adjusted EBITDA" that presents a more favorable financial picture. However, the legitimacy of these add-backs is crucial and must be carefully scrutinized.
Legitimate Add-Backs
Owner's Compensation Adjustments
Owners of privately held companies often pay themselves salaries or bonuses exceeding what a new owner would pay — a valid add-back.
Taxes & Benefits
Adjust for related taxes and benefits tied to owner's compensation. If employees are expected to leave post-acquisition, their benefits may also qualify.
Severance & Lawsuit Settlements
Typically one-time occurrences and potential add-backs — though frequent occurrences warrant further due diligence.
Personal Expenses (FAAP)
In closely held companies, owners often mix personal and business expenses — "Family Accepted Accounting Principles." These are legitimate add-backs unlikely to continue under new ownership.
Common Personal Expenses That Can Be Added Back
Typical FAAP Add-Backs
Club memberships (country, hunting, health)
Owner's car payments, insurance, and gas
Payroll for family members
Travel, meals, and entertainment unrelated to business
Any other personal expenses unrelated to the business
Important Tax Note: While FAAP expenses may be allowable as add-backs, they can be a gray area for taxation. Consult a qualified accountant to determine the correct tax treatment for these expenses.
What Add-Backs Are NOT Legitimate?
Recurring Expenses
If an expense appears consistently on the P&L (income statement) — even if labeled "one-time" — it is not a legitimate add-back. Example: yearly "one-time" legal expenses are recurring and should not be added back.
Post-Acquisition Expenses
If the company will continue to incur an expense after the acquisition, it is not a valid add-back. Buyers pay close attention to this and will challenge any dubious claims.
A general rule of thumb: if the expense will persist under new ownership, it cannot be legitimately removed from EBITDA.
Key Takeaway for Buyers & Sellers
For Buyers
Scrutinize every add-back presented by the seller. Ask tough questions and ensure expenses are truly non-recurring or extraneous to future operations.
For Sellers
Avoid overreaching with add-backs that won't disappear post-sale. Invalid add-backs lead to disputes and can negatively impact negotiations and deal value.
Sample Add-Backs for M&A Evaluation
Determining appropriate add-backs is crucial when assessing a business for sale. Below is a real-world example of common add-backs — we can derive the 2025 Trailing Twelve Month (TTM) figures from your monthly financials, so no need to calculate anything upfront.
Sample Add-Backs 2025
These figures are based on trailing twelve months — don't worry about calculating TTM yourself. Just share your monthly financials and we'll take it from there.
Other Considerations
401K Matches
Employer 401K contributions tied to owner or departing employees may qualify as add-backs.
Normalized Salaries
Adjust owner and key employee salaries to reflect industry norms for the role under new ownership.
Trade Group & Membership Dues
Trade group memberships and other personal memberships that won't carry over post-acquisition.
Personal Fuel Expenses
Personal fuel costs for owners and family members (e.g., Jim, Suzy, Junior) are legitimate add-backs.
Always review add-backs carefully to ensure they meet the criteria of being non-recurring and irrelevant to future owners.
Work With Good Hope Advisors
Navigating add-backs and EBITDA adjustments requires experience, diligence, and expertise. Good Hope Advisors helps buyers and sellers achieve fair, transparent, and successful M&A outcomes.
Scrutinize Add-Backs
Ensure every adjustment is truly non-recurring and defensible.
Avoid Disputes
Invalid add-backs damage negotiations and deal value.
Consult Experts
Work with qualified advisors and accountants throughout the process.