If you’re thinking of selling your e-commerce business, you will most likely encounter a term you may have never heard of before but that will be very important in arriving at the highest value for your firm: Add-backs.
As the name implies, add-backs are expenses that can be added back into your EBITDA (earnings before interest, taxes, depreciation and amortization) and potentially boost the value of your business. Add-backs are one-time, nonrecurring and personal expenses incurred by the current owner but not likely to be borne by the buyer, which could add additional profit to the buyer once the business changes hands. As a result, they give a more accurate picture of your business’s real earning power on an on-going basis, and thus its true value.
Add-backs can have a dramatic impact on your company’s EBITDA and the actual valuation it attracts. In fact, we’ve seen cases where the owner felt they couldn’t sell their business because it looked like it was losing money. But on closer inspection, when add-backs were considered and EBITDA adjusted accordingly, the enterprise looked considerably better and worth a lot more.
For example, a company with EBITDA of $5 million that attracted a multiple of 8 times would fetch a price of $40 million. However, if EBITDA were adjusted upward to, say, $6 million after add-backs, that same company would be valued at $48 million. That’s quite a difference.
At FOCUS, the biggest addback opportunity that we found was with a company in the home health care industry. Our client was selling to a hospital, which had a far more favorable Medicare reimbursement schedule than our client did as an independent company. We were able to convince the seller to apply its reimbursement schedule to our client’s earnings rather than the stingy one allotted to for-profit independent agencies. This roughly doubled the profitability of the business for the buyer and dramatically increased the purchase price we could negotiate.
As you can see from this example, add-backs are common in the valuation of all types of businesses, not just e-commerce.
But let’s backtrack a little. So what exactly are add-backs?
Essentially, add-backs are expenses incurred by the current owner that may not carry over to the buyer. For example, R&D and marketing expenses that the current owner incurred to get the business off the ground could probably be added back, as the new owner likely won’t need to replicate those expenses. If you were involved in a lawsuit that has been settled, your legal expenses would also not likely be borne by the new owner, so that could be added back into your firm’s EBITDA, as it is nonrecurring. However, if your firm is frequently in litigation for one reason or another, that would likely count as a regular cost of doing business and could not likely be added back.
Capital expenses are another potential source of add-backs. If you have high-interest rate loans, for example, but the buyer has no debt or can access lower-cost capital, that expense could be added back.
Personal expenses and above-market compensation to the current owner are also common add-backs. For example, some business owners pay themselves and family members high salaries and bonuses; however, if the new owner doesn’t plan to play such an active role or pay himself a lower salary, previous compensation levels could be added back. Similarly, the cost of perks that current owners provide themselves with, such as the use of a company-paid vehicle, might also be added back if the new owner eschews those things. If the current owner owns the building or warehouse where the business operates and charges a lower—or higher—than market rent, the prospective buyer would need to determine what a true fair market value for rent in the area is. In fact, add-backs can be negative—a contradiction in terms, to be sure—if the prospective buyer can demonstrate that certain expenses will continue to be incurred by them and therefore reduce the value of the business.
Needless to say, add-backs can be a gray area and a source of disagreement at the negotiating table. The seller may feel their add-backs are perfectly legitimate and justified, while the buyer may raise their eyebrows. It is the buyer’s responsibility to determine whether the EBITDA add-back is legitimate, while it’s the seller’s job to justify it.
This being the case, both buyers and sellers have an interest in calculating add-backs honestly, since one side can challenge the other party. This is where the services of a good investment banker, business broker or accountant—expenses that can be added back, by the way—play an important role in determining what add-backs are fully justified in valuing the enterprise. We also recommend that business owners get a professional business evaluation every year to get a more accurate reading of the value of their business.
If you’re looking to sell your e-commerce business in the near future or would like a valuation of what it might be worth, please reach out to FOCUS’s e-commerce team. In addition to a strong team of bankers, our team includes strategic advisors who are former e-commerce CEOs with experience scaling and exiting businesses. We leverage this experience to help best articulate your company’s value proposition to the marketplace and achieve successful exits. FOCUS e-commerce clients also benefit from our extensive industry relationships and inside knowledge of current valuations and deal structures.