Add-backs or adjustments to EBITDA are shown in the Information Memorandum (IM). These items are typically listed in the section within the IM which is entitled “Adjustments to EBITDA” or “EBITDA calculation” or similar.
Add-backs can take several forms, as follows:
- Items which are classed as being personal to the current owners of the business, but not necessarily items which a new owner would incur on taking over ownership of the business. For example, these include pension contributions for directors, healthcare costs, costs of personal motor vehicles, salaries for additional/non-working family members, purchase of personal items, one-off expenditure, etc.
- Non-cash items. These are specifically the amortisation of goodwill and depreciation costs. Both of these also need to be added back to Operating Profit as they are merely accounting entries and not true expenditures. These two items are specifically influenced by the company’s respective accounting policies on each. For example, goodwill might be written off in the P&L account over 5 years, whereas depreciation can be written off over between 1 and 5 years, depending on the type of asset concerned. Either way, these two items increase the adjusted EBITDA figure.
- This is the cost of borrowing money to run the business on a day-to-day basis. Having the working capital to run the business is vital, but it does come at a cost if you need to borrow from a third party, such as a bank or an asset-based lender. These costs are part of the running of the company; however, a new owner might not need to borrow money to run the business day to day, and hence, the charge for this, i.e., the interest element, is added back in the adjusted EBITDA calculation to increase the profit.
- This is not an add-back as such, but in order to derive EBITDA, you must use the figure of operating profit before taxation in the P&L account.
Effect of add-backs
Essentially, by adding these items back to the annual Operating Profit stated in the Profit & Loss Account within the year‑end financial statements, you create an upward adjustment to the Operating Profit figure. Under new ownership, this means the Operating Profit would be a higher number than that shown in the historic accounts.
This adjusted figure can then be used when considering the longer‑term maintainable EBITDA under new ownership, and it is this adjusted EBITDA that a funder will focus on when you are in discussions about a funding proposal.
Deductions from EBITDA
As there are add-backs to EBITDA, there are also deductions from it. One major item in this regard is the Director's replacement cost. This is relevant in circumstances where one or more of the existing owners are performing a key function within the business, and by removing that Director from the business on the sale of the company, a replacement will need to be found to cover the role and specific duties undertaken. Typically, a sum of £50,000 per director will be used as a replacement cost representing the salary required to be paid to cover the seniority and duties of the role in question.