The Add-Back Fight: What Survives Due Diligence

The $500K Disappearing Act

Ask a seller what expenses disappear post-sale, watch them find $500K. Ask a buyer to verify those add-backs, watch $300K vanish. The gap between seller math and QoE reality can be big. That's not fraud or incompetence. It's different incentives meeting different standards.

Sellers see their business intimately. They know that $8K monthly "consulting" payment to their brother-in-law produces zero value. They know the company truck sits in their driveway and that a big part of their "sales and marketing" expense is a golf membership. These are obvious add-backs to them.

Buyers see risk and precedent. That consulting payment might be under-the-table compensation to a key employee. That truck might be used for customer deliveries twice a month. Without documentation, they assume the worst. Their lender demands it.

Here's the test both sides should use: Would a rational new owner incur this expense? If no, it's an add-back. If maybe, document why not. If yes, stop trying.

Owner Compensation: The Great Debate

Owner compensation creates more valuation arguments than everything else combined. The owner making $400K says "I could hire someone for $150K." The buyer says "You work 70 hours across five roles."

The seller's view: "I built this business. I know what it takes to run it. One good manager at $150K replaces me." They're not wrong about the business knowledge. They're wrong about the workload.

The buyer's view: Track the owner's actual duties:

• CEO Seat: $150K
• Sales Manager: $100K
• Part-time tech expert or HR: $50K

Total replacement cost: $300K

That's a $300K gap in EBITDA. At 4x, that's $1.2M in value. This isn't small.

How to bridge it:

• Sellers: Create an org chart showing your actual roles. Get market comp data for each. If you genuinely work part-time, show it with time logs. Even better, if the Company can run without you as-is, and you stop in twice a week to keep people in check, sell it with as a General Manager ready to formally takeover.
• Buyers: Don't assume every owner inflates hours. Some really do work 20 hours weekly. But verify with workload through the diligence process.

It's not abnormal seen a manufacturing owner claim $300K in excess compensation. Buyer discovered he was also chief engineer, personally designing custom parts. Replacement cost: two people at $275K combined. Add-back shrinks to $25K.

Personal Expenses: Documentation Matters

Every business runs some personal expenses. It's a tax strategy as old as pass-through entities. But "everyone does it" doesn't mean "buyers accept it."

Vehicles are ground zero. The company owns five autos. Three are box trucks wrapped with logos and driven by employees. One is an F150 that sits at the owner's house. Another is a Porsche at the vacation home. The Porsche is clear add-back, the truck can be if proven, both need clear proof – especially if the seller wants to keep them post-transaction.

Sellers think: "It's obvious these are personal." Buyers think: "Prove it or I'm cutting it."

Travel and entertainment requires nuance. That "conference" in Maui where you attended one session? Sellers call it personal. Buyers want to know if you met clients there. Those monthly dinners "with customers"? Buyers want to know if it was business or pleasure. This isn't a tax audit – it's understanding.

Family on payroll gets brutal. Your spouse answering phones twice a week for $60K? That's getting cut to $15K. Your kid's summer internship at $30K? Gone unless they actually worked.

Example: A landscape company showing $180K in personal add-backs:

• Two personal vehicles: $48K (accepted with documentation)
• Owner's wife salary: $75K (reduced to $25K for actual bookkeeping)
• Country club membership: $15K (rejected, entertained clients there)
• Personal cell phones: $6K (accepted)

Final accepted add-backs: $79K, not $180K

For buyers: Get the details. Proof it during diligence. Your QoE provider will.

For sellers: Start documentation now. Separate personal from business. The cleaner the separation, the easier the add-back.

One-Time Events That Aren't

"One-time" professional fees become recurring nightmares when patterns emerge. Sellers see isolated incidents. Buyers see systemic issues.

Legal fees tell stories. One employment lawsuit? Add-back. Three in five years? You have an HR problem. One contract dispute? Add-back. Annual disputes with suppliers? That's your business model.

Consultants and advisors require scrutiny. ERP implementation? One-time. Outsourced "strategic planning" that does the accounting? That's recurring. The test: Will the business need this service again?

A distribution business claimed $190K in one-time add-backs:

• Warehouse management system implementation: $100K (accepted)
• Legal settlement with former employee: $50K (accepted, first time)
• Strategy consultant: $40K (rejected, expansion ongoing)

Accepted add-backs: $150K

For buyers: Pull three years of P&Ls. Pattern recognition beats seller narratives. If it happened twice, it'll happen again.

For sellers: True one-time events have clear triggers. Document the extraordinary nature. Show why it won't recur.

The Add-Backs That Never Survive

Some adjustments die in every deal. Stop trying these:

• "We could cut costs but choose not to" isn't an add-back. Your inefficiency is your actual margin. Buyers aren't paying for problems they have to fix.
• Deferred maintenance doesn't disappear. Claiming you "over-maintained" this year sounds smart until buyers check your equipment age.
• Customer concessions you gave aren't adjustable. If you cut prices to keep business, that's your real pricing power.
• Management layer elimination rarely works. "We could cut two managers" means you're overstaffed or lying about workload.

For buyers: These failed add-backs could be a signal seller. Dig deeper everywhere else.

For sellers: Attempting weak add-backs undermines credibility on legitimate add-backs. Stick to real adjustments.

Your Add-Back Audit Checklist

Buyers, before signing that LOI:

• Get monthly P&Ls for 24 months
• List every claimed add-back
• Mark: Accept / Reject / Verify
• Recalculate DSCR with adjusted number
• If it breaks, adjust the offer pre-LOI

Sellers, before going to market:

• Create add-back documentation folder
• Include: receipts, contracts, logs, photos
• Get third-party verification where possible
• Calculate three scenarios: aggressive, documented, conservative
• Price from documented, not aggressive