We're getting ready to sell our manufacturing business and our advisors keep warning that buyers will challenge our EBITDA adjustments. They want us to justify every add-back. What's the best way to defend them during due diligence without looking like we're padding the numbers? Any tips on prepping for those conversations?
EBITDA
How to defend your EBITDA adjustments during due diligence
Honestly, the more you can quantify the adjustment, the better. If it’s a one-time legal fee, show the invoice and the reason. If it’s a personal expense, show the receipts. Vague add-backs get shot down fast. We had a $200k “owner discretionary” add-back once and the buyer’s team laughed us out of the room.
CardboardRocket is right. We also provided a bridge from reported EBITDA to adjusted EBITDA with line-item support. That way the buyer can’t claim we’re hiding anything. If you can’t produce a paper trail, don’t bother adding it back.
One thing that helped us: don’t argue about the add-back itself, argue about the normal level of that expense. If you add back $150k for a one-time equipment repair, show that the previous 5 years averaged $10k for repairs. That way the buyer sees you’re not just inflating earnings.
What about add-backs for family members on payroll? That’s always a fun one. We had to justify my brother’s salary as “not market rate” but still an add-back. Buyer didn’t buy it. I think there’s a fine line between legitimate and ridiculous.
Everything I add back, I put in a separate column with a note and a source. During diligence, I juwst hand over the spreadsheet. If they question something, I give them the backup. By the time we get to management meetings, most of the adjustments are already accepted. Preparation is key
Thanks, all. The paper trail advice seems obvious but I guess a lot of sellers don’t do it. MergersAndInquisitions, when you say you include a note and source, whaat does that look like? A separate file with invoices, or just a reference?
RustyGearshift – I note the invoice or document ID and keep a hyperlink to the file in the spreadsheet. Then I keep the actual PDFs in a folder structure that matches the adjuwtment list. So if they want to see the $75k consulting invoice from 2022, I can pull it up in 10 seconds. They love that.
Be ready for the “quality of earnings” guys to reclassify your add-backs as recurring. They have a habit of assuming anything that happened in The past 3 years is normal. I’d preempt that with a multi-year analysis showing the trend.
Also, consider what the buyer will do with the adjusted number. If they’re using it to set the purchase price multiple, they’re going to be extra skeptical. Sometimes it’s better to present a conservative adjusted EBITDA and then negotiate instead of trying to defend aggressive add-backs.
That’s a good point, NumberCruncher. We actually left a couple of small add-backs off the table to appear reasonable. The buyer appreciated it and we closed faster. Not everything has to be a battle.
If your EBITDA add-backs are bigger than the deal itself, maybe reconsider. Haha. But seriously, I’ve seen sellers claim $2M in adjustments on a $5M business. That’s when the buyer’s banker starts sweating.
Appreciate all the perspectives. We’re going to do a dry run with our advisory team next week and see where the weak spots are. I’ll report back if we survive. Thanks again!