Normalising EBITDA for a sale
Why reported EBITDA understates value
Founder-run companies are rarely run to maximise reported profit. Owners pay themselves differently from a hired manager, put some personal costs through the business and absorb one-off costs as they come. Normalising strips those choices out to show what the business would earn under a new owner.
The three grades
Grade A add-backs, such as above-market owner pay and documented one-off legal costs, are usually accepted in full. Grade B add-backs, such as family payroll or above-market related-party rent, are accepted with evidence. Grade C add-backs, such as pro-forma savings or lost revenue, are usually challenged. The sandbox applies a typical acceptance rate to each grade.
From EBITDA to SDE
Smaller businesses sold to an owner-operator are priced on seller’s discretionary earnings instead, which adds back the full owner salary. See both numbers side by side in the SDE vs EBITDA calculator, and read the EBITDA add-back standard (opens in a new tab) for the full list of accepted adjustments.
Preparing the schedule
Build an add-back schedule for the last three financial years and the trailing twelve months, with the evidence for each line. Then run the QofE readiness assessment (opens in a new tab) to check the rest of your numbers before a buyer’s accountant does.
Frequently asked questions
- What is an EBITDA add-back?
- An add-back is a cost in your accounts that a new owner would not incur, added back to reported EBITDA to show the true earning power of the business. Common examples are above-market owner pay, personal expenses and one-off legal or restructuring costs.
- What is the difference between adjusted and defensible EBITDA?
- Adjusted EBITDA is reported EBITDA plus every add-back you claim. Defensible EBITDA is the part a buyer’s accountant will accept after diligence. The gap between the two is the price you risk losing late in the process.
- Which add-backs do buyers reject?
- Pro-forma savings that have not happened, revenue from lost customers, recurring costs labelled as one-off and owner pay that was already at market rate. These are usually challenged in the quality of earnings review.
- How do I make an add-back defensible?
- Show the invoice, the reason it will not repeat and the period it relates to. For owner pay, show a market salary benchmark. A short schedule with evidence for each line is far more persuasive than a single adjusted number.
- How much is an add-back worth?
- Each dollar of accepted add-back is worth your EBITDA multiple in enterprise value. At 6x, a $50K add-back adds $300K to the price, which is why buyers test every line.