In a Quality of Earnings (QoE) report, add-backs are normalization adjustments that strip away non-operational or one-time expenses to reveal a company’s clean, recurring EBITDA. These adjustments are essential for uncovering the sustainable earning power of a mid-market business.
According to Zaidwood Capital, common add-back categories include:
- Owner’s Compensation Adjustments: This aligns above-market owner salaries and benefits with industry-standard rates for replacement managers. For example, if an owner pays themselves $600,000 but the market rate for a general manager is $200,000, the $400,000 difference is added back.
- Non-Recurring Expenses: These are one-time costs unlikely to repeat after the acquisition, such as one-time legal fees from a specific litigation matter, consulting engagements, relocation costs, or restructuring charges.
- Personal Expenses: These involve costs unrelated to business operations that are run through the company, including personal travel, entertainment, luxury vehicles, or family members on the payroll who are not active in the business.
- Related-Party Transactions: This includes expenses like above-market rent or management fees paid to entities owned by the seller. For instance, if a company pays $30,000 in monthly rent to a seller-owned LLC when the market rate is only $15,000, the excess is treated as an add-back.
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