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Seller Discretionary Earnings and the Add Backs Buyers Accept

Price starts with earnings, and Cleveland Business Brokers Desk sees owners lose money here more than anywhere else.

A little preparation protects your number.

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Quick takeaways

  1. Seller discretionary earnings show what one working owner could take home, and most small company prices start there.
  2. An add back is a cost removed from the books, and buyers keep only the ones they can verify.
  3. Money that merely arrived, like proceeds from a sold truck or a loan, is not operating income.
  4. Equipment heavy firms should expect buyers to treat part of depreciation as real maintenance cost.

What the buyer is trying to learn

A buyer wants to know what one working owner could take out of the company in a year. For smaller firms that figure is seller discretionary earnings, often called SDE. It includes the owner's pay, benefits and perks plus the profit left over.

Larger companies with managers in place are priced on EBITDA. The difference is who gets paid: with SDE the owner's full pay is added back, and with EBITDA a market rate manager is deducted first.

Add backs that usually hold up

  • The pay and benefits of one working owner
  • One time legal or consulting costs, with invoices
  • Personal vehicles or trips run through the company, with records
  • Interest and depreciation, with limits for equipment heavy firms

Every add back needs a paper trail. If a buyer cannot match an item to a receipt or bank record, the item disappears from the math.

Add backs that get cut

Money that happened to arrive is not cash flow. Selling a company truck or taking a loan creates a one time deposit, and presenting it as earnings costs you trust once diligence starts.

Owner draws do not appear on the profit and loss statement, so they cannot simply be counted. They must be recast properly.

Cash that never touched the books

A seller is paid only for what can be proven. Hiding sales to save about twenty percent in tax can cost two or three times that amount in lost sale value at a typical multiple.

Equipment and the depreciation trap

Shops, fleets and contractors buy machines that wear out. Buyers often accept only part of depreciation as an add back and treat the rest as spending they will have to fund.

Getting ready

Ask your CPA to bring the profit and loss statement current, reconcile the bank accounts and list each add back with support. Then read how customer concentration changes the multiple.

When the numbers are ready, request a price opinion.

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