Why it matters
Add-backs are costs the seller says a new owner would not carry, added back to reported profit to show what the business really earns. Because the price is a multiple of that earnings figure, every add-back is multiplied too. In a fictional example at a multiple of three, a £40,000 add-back adds £120,000 to the asking price.
Some add-backs are sound: the salary of one working owner, a legal bill for a dispute that has ended, the personal share of a car run through the business. Others do not survive a close look. A "one-off" repair that appears every year is a running cost. Marketing cut before a sale will need to be restored. A spouse who keeps the books for nothing is a cost you will have to pay, not a saving.
Size matters as well as quality. When the add-backs are larger than the reported profit, most of the price rests on the seller's explanations rather than on the accounts.
Loupe's method follows the same discipline. SDE adds back the salary and benefits of one full-time working owner, while pay for any other working owner stays in costs. The valuation tool asks only for one-off or discretionary costs that can be evidenced, and adjusted EBITDA then deducts a market salary for someone to do the owner's job. An add-back without evidence should come out of your figures until it has some.
Add-backs are costs added back to reported profit to show what a business would earn under a new owner. They raise SDE and adjusted EBITDA, so each one needs evidence.
The asking price is the price a seller or broker puts on a business when it is listed. It is an opening position, not a valuation, and what it includes varies from listing to listing.
Seller's discretionary earnings (SDE)
Seller's discretionary earnings is the yearly financial benefit a business gives one full-time working owner, before financing costs, non-cash charges and one-off spending.
How to spot it
Ask for a bridge from net profit before tax to the earnings figure in the listing, one line per item, for each of the last three years. Then look for:
- An SDE or EBITDA figure with no bridge at all.
- Round numbers or loose labels such as "owner costs", "non-recurring" or "discretionary".
- The same one-off item appearing in more than one year.
- Salaries for more than one owner added back.
- Costs the business needs to keep trading, such as marketing, maintenance, software or staff cover.
- No adjustments in the other direction, for example family members paid below market rates (see family or related staff paid off-market rates) or rent paid to the owner below market (see related-party transactions).
Net profit before tax is what a business earns after all its costs, including interest and depreciation, but before tax on its profits. It is the starting point for SDE and EBITDA.
EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.
Questions to ask the seller
- Can you take me from net profit before tax to the earnings figure in the listing, line by line?
- What evidence supports each add-back?
- Which of these costs appeared in earlier years, and why will they not recur?
- Who does the work you do today, and what would it cost to hire someone to do it?
- Are there costs a new owner would carry that the business does not pay today?
- Has an accountant reviewed the add-backs?
Documents to request
- A schedule of every add-back by year, showing the ledger account each one sits in
- Invoices, receipts and payroll records supporting each item
- General ledger detail for the accounts affected
- Payroll records for the owner and any family members, including benefits
- Filed accounts and tax returns for the same years
- Any quality of earnings report or accountant's review of the figures
A quality of earnings review is an accountant's analysis of whether a business's reported earnings are accurate, sustainable and correctly adjusted. It is not an audit.