Which add-backs are legitimate, and which should you question?

Which add-backs usually hold up?

An add-back is an expense the seller paid that a new owner will not. SDE is pre-tax profit plus these items. They hold up when they are real, documented and will not continue under you.

• One owner's salary, payroll taxes and benefits. SDE adds back one owner. Verify it in payroll records and the tax return.
• Interest. The seller's debt is paid off at closing. Your debt is a separate calculation.
• Depreciation and amortization. Non-cash accounting charges. Accept them, then subtract the real capital spending the business needs each year.
• Documented personal expenses. The owner's vehicle, phone, personal travel or family insurance run through the business. Ask for receipts or statements, not a round number.
• Truly one-time costs. A lawsuit settlement, a relocation, an uninsured loss. Confirm it did not happen in prior years too.

Which add-backs should you question?

These are where sellers and brokers stretch. Each one needs evidence, and some should be refused.

1. Family on payroll. If the spouse or child does real work, the work still needs doing. Add back only the excess over what a replacement would cost.
2. Recurring "one-time" items. Repairs, legal fees or bad debts labeled one-time but present in three straight years are a cost of doing business.
3. A second owner's salary. SDE adds back one owner. A second working owner is a cost you will replace.
4. Owner hours. An owner who works 60 hours a week may need to be replaced by more than one person. Price the replacement, not the title.
5. Pro forma revenue. "Revenue we would have had" or new contracts not yet billed are not earnings. SBA coverage is measured on historical or adjusted historical cash flow; projections cannot be used.
6. Savings the buyer would create. Do not pay the seller for your own improvements.
7. Unreported cash. Income not on the tax return cannot be verified. SBA coverage is measured on historical cash flow, so a buyer financing with an SBA loan generally cannot pay for it.

What are negative add-backs?

Some adjustments reduce earnings. Sellers rarely volunteer them. Look for:

• Below-market rent paid to the owner's own property company. A new lease at market rent is a higher cost.
• Unpaid labor by the owner's family.
• Underpaid key employees who will want a raise when the owner leaves.
• Deferred maintenance and capital spending: trucks, equipment, software or a roof that is overdue.

Worked example: an add-back audit

A listing shows $400,000 of SDE. Pre-tax income on the tax return is $150,000. The seller claims $250,000 of add-backs. Illustrative audit:

1. Owner salary and benefits, $124,000: verified in payroll. Accept $124,000.
2. Depreciation, $35,000: accept $35,000, and note it for the capital spending check.
3. Interest, $16,000: accept $16,000.
4. Spouse's salary, $45,000, described as "not active": the spouse does the bookkeeping. A part-time bookkeeper would cost $30,000. Accept $45,000 − $30,000 = $15,000.
5. "One-time" equipment repairs, $20,000: similar repairs appear in each of the prior three years. Accept $0.
6. Owner's vehicle and phone, $10,000: documented. Accept $10,000.
7. Accepted add-backs: $124,000 + $35,000 + $16,000 + $15,000 + $0 + $10,000 = $200,000. Rejected: $250,000 − $200,000 = $50,000.
8. SDE after add-back audit: $150,000 + $200,000 = $350,000.
9. Negative add-back: rent paid to the owner's LLC is $36,000 a year; market rent is $60,000. Extra cost $24,000. SDE = $350,000 − $24,000 = $326,000.
10. Price at 2.57x on the claimed SDE: $400,000 × 2.57 = $1,028,000.
11. Price at 2.57x on the audited SDE: $326,000 × 2.57 = $837,820.
12. Difference: $190,180.

Nothing in this example required fraud. It took a generous label on the spouse, a habit of calling repairs one-time and a friendly lease. Inflated SDE figures are often built this way, one reasonable-sounding label at a time.

Should you pay for a Quality of Earnings report?

For SBA Initial Acquisitions and Business Expansions with a purchase price of $3 million or more, the lender must commission an independent QoE, and its earnings are used in the coverage calculation. Below that, it is your choice. A deal-cost survey with a median deal size of about $4 million found a median QoE cost of $40,000, with "QoE-lite" reviews under $10,000. QoE proposals for SBA deals have run $7,500 to $30,000 or more. Against a $190,180 swing like the one above, a limited-scope review is usually worth it.

Where these numbers come from: The 2.57x SDE average is from Beancount's analysis of BizBuySell data. QoE rules are from SBA SOP 50 10 8.1 as summarized by Beancount. QoE costs are from the Big Deal Small Business deal-cost survey and Searchfunder. Audit figures are illustrative. SOP 50 10 8.1 applies to loans that receive an SBA loan number on or after October 1, 2026 (SBA Information Notice 5000-880695).

Related questions

What documents prove an add-back?

Payroll records for salaries, general ledger detail for expenses, invoices and receipts for one-time items, and three years of tax returns to check whether "one-time" items repeat. Bank statements tie it together.

Will an SBA lender accept the seller's add-backs?

The lender measures coverage on historical or adjusted historical cash flow, and decides which adjustments it accepts. For deals at $3 million or more, the QoE earnings are used. Expect the lender to be stricter than the listing.

Is depreciation always a fair add-back?

In the SDE formula, yes. In your cash flow, only if the business does not need to replace equipment. Subtract average annual capital spending before deciding what you can pay.

What if the seller won't document an add-back?

Treat it as a cost. An add-back the seller cannot prove is an add-back you cannot finance.

What comes next

With audited earnings in hand, you can judge the deal itself. See how to tell a good deal from a bad one. If you plan to buy several businesses, set one add-back policy now and apply it to every target, because consistent earnings definitions are what a lender, an investor and eventually an auditor will ask for at the holding company level.

Related articles

• What is the difference between SDE and EBITDA?
• How do you tell a good deal from a bad deal?
• How are small businesses valued?
• Do you need a quality of earnings report to buy a small business?
• How do you build a holding company for acquisitions?

Meraki Dealmakers is a service of Meraki Partners, LLC, an advisory firm. It is not a broker-dealer, investment adviser, business broker, law firm or accounting firm. This article is general information, not legal, tax or investment advice.