One of the most negotiated aspects of a transaction is “Adjusted EBITDA”. You’ll probably hear the term used often in conversation when talking with your friends. The problem with “adjustments” is that buyers are extremely suspicious of them. To most buyers, hearing about “adjustments” is akin to a teacher hearing “my dog ate my homework” from a student.

Sellers often try to “normalize” their numbers to maximize adjusted EBITDA, removing non-recurring, personal, or unusual expenses to illustrate what the business would look like under professional ownership. However, what you, as a seller, think should be added back and what a buyer is willing to accept may be two very different things.

In Deal Note® 50, we discussed the main categories these “addbacks” fall into. Today, we’ll discuss addbacks that are often contested by buyers.

  • “Excess” R&D or engineering costs – Some sellers argue that certain product development efforts may be non-recurring. But buyers often argue that, in A&D, R&D is often core to staying competitive.
  • Family members / friends on payroll – If they perform a real function, even part-time, buyers may challenge removing their compensation.
  • Vacant Roles – Often overlooked, vacant roles can be a negative add-back. If a key function is currently being filled by an experienced employee working essentially two roles, buyers may assume they’ll need to hire for it post-close.
  • Recurring professional services – ongoing outsourced consultants, IT, or HR support. Sellers may view some of these as addbacks. Buyers often view these as routine costs of running the business.

When it comes to “Adjusted EBITDA”, documentation is everything. If you, as a seller, can show that a cost incurred in the past will not recur in the future under new ownership, most buyers will accept it. But, “adjustment” costs that are needed to successfully operate the business will be exhaustively contested and ultimately rejected by buyers during due diligence. Accordingly, your goal, as a seller, is to present a well-documented and credible financial narrative that defends each of your adjustments to EBITDA. 

Have a great day,

Max McFarland
Associate