When preparing our financials for an exit, how do we distinguish between legitimate pro forma add-backs and embedded operating costs that a buyer will insist on keeping in our overhead?

Question

Tyler Smith · Accepted Answer

During an exit process, owners often attempt to adjust their historical earnings by claiming every expense they can think of as a discretionary add-back. While normalizing earnings is a standard exercise, aggressive or unsupportable add-backs destroy your credibility during financial diligence. If an acquirer catches you attempting to add back legitimate, recurring operational costs, they will subject every line item on your profit and loss statement to severe skepticism.

A legitimate add-back is an expense that is strictly non-recurring, unusual, or personal to the seller. Examples include your personal vehicle lease, above-market owner compensation, one-off litigation settlements, or non-recurring transaction advisory fees. Buyers readily accept these adjustments because they will not continue under new ownership.

An embedded operating cost, by contrast, is an expense required to run the business at its current capacity. If you underpay key executives, neglect vital software licenses, run bare-bones marketing, or fail to replace aging equipment, buyers will reject those add-backs immediately. In fact, forensic accountants will implement reverse add-backs, reducing your reported EBITDA to account for the market-rate salaries and overhead required to replace your functions.

Two years prior to going to market, clean up your profit and loss statements. Remove personal discretionary spending from company books entirely. Pay yourself and your leadership team true market-rate compensation. Run the company with the actual corporate overhead required to sustain growth. Delivering a defensible, battle-tested EBITDA number ensures you capture maximum value without painful valuation adjustments.