SDE Add-Backs: What Sellers Can Add and Buyers Accept

Start with pre-tax net income from your profit and loss statement and build up in steps:

1. Add the owner's salary or draw, plus payroll taxes on it. If two owners work in the business, add back both, and the buyer will decide how many replacements are needed.
2. Add the owner's benefits paid by the company, such as health insurance and retirement contributions.
3. Add interest expense, since a buyer will finance the purchase differently.
4. Add depreciation and amortization, which are non-cash.
5. Add personal expenses the company paid, such as a personal vehicle or family travel.
6. Add non-recurring costs, such as a one-time legal settlement or a move.
7. Subtract non-recurring income, and correct any expense that's understated, such as rent paid to a relative at below-market rates.

Use three years of history if you have it, and show the adjustments year by year so a buyer can see trends, not just a single good year.

Say a small service business reports $90,000 in pre-tax net income. Say the owner took a $120,000 salary, the company paid $15,000 in interest and recorded $25,000 of depreciation. Say it also paid $18,000 for the owner's health insurance and $9,000 for a personal vehicle, had a $12,000 one-time legal settlement and paid a family member $30,000 who doesn't work in the business.

Say the sum of those items is $319,000. Now say the company rents its space from the owner's relative at $20,000 a year below the market rate, so a buyer would pay more. If you subtract that, SDE in this example is $299,000.

A buyer using a multiple of SDE will focus on the pieces that aren't obviously business-related. In this example, the family payroll, the vehicle and the legal settlement total $51,000, and each needs support. The below-market rent adjustment works against you, but showing it builds credibility, because buyers find it anyway.

Buyers accept adjustments that are clearly personal or clearly one-time and that you can support with records:

• The owner's salary, benefits and payroll taxes, up to the owner's role being filled by a replacement the buyer will handle themselves.
• Interest, depreciation and amortization.
• Personal vehicle, phone, meals and travel that didn't serve the business, backed by statements.
• A specific one-time legal, moving or renovation cost with invoices.
• Family members paid above market for work they don't do, or paid for no work at all, with payroll records and a description of their role.
• Charitable donations and personal memberships paid through the company.

Each item should have a dollar amount for each year, a one-line description and the document that proves it.

Expect questions on any adjustment that looks like it keeps recurring, is hard to verify or benefits the business:

• A one-time expense that shows up every year. Repeated legal fees, repairs or consulting projects are part of running the business.
• Owner replacement pay set too low. If a buyer must hire a general manager, they'll subtract that cost or pay less.
• Marketing or R&D cut to boost profit. Buyers will restore it if growth depends on the spend.
• Deferred maintenance. Skipped repairs make current profit look better than the business can sustain.
• Unsupported cash payments. No receipt, no add-back.
• Add-backs that grow with each version of the listing. A schedule that changes between drafts loses trust quickly.

A useful test: if you'd want the buyer to keep paying the expense in order to run the business well, it isn't an add-back.

Build a schedule with one row per adjustment: year, amount, category, explanation and supporting document, such as an invoice, payroll record or bank statement. Reconcile the total to your books and tax returns, and explain any differences. Have your CPA review it before it goes into a listing. Later, a buyer's accountant may run a quality of earnings review, and a schedule you built carefully makes it faster.

SDE fits businesses where the buyer will work in the business. EBITDA fits larger companies with managers in place, where the owner's pay is replaced by a market-rate salary in the cost base. If you're not sure which one applies, read SDE vs EBITDA, and see valuing a small business by revenue multiple for how multiples work. The financial due diligence checklist for sellers covers the rest of the records a buyer will request.

Marketplaces such as Acquire.com and Flippa ask for adjusted earnings in listings, and buyers will test your figures. Get a CPA or broker to check the schedule before you post it.