One of the first steps in conducting a business valuation is the process of recasting of a Seller’s financials. In this exercise, certain expenses are added back to the bottom line, effectively adjusting net income, in most cases to the Seller’s benefit.
At a starting point, for instance, there are broadly accepted recast adjustments (commonly known as “addbacks”), which consist of: interest expense, taxes, depreciation, and amortization. SBA lenders and buyers alike recognize and accept such addbacks in a financial recast. It’s unusual for such addbacks to create questions or issues during a due diligence process.
A second category of generally acceptable addbacks involve owner’s salary and direct owner benefits. For example, if a small business owner works full-time in the business and takes a salary of $75,000, this amount can be added back along with the requisite payroll taxes as well. Other benefits such as pensions and health insurance can be commonly added back without question.
A little creativity never hurt
A third category of expenses, commonly described as personal expenses, fall into more of a grey area. Addbacks that fall into this questionable category include automobile expenses, cellphone expenses, personal travel, and meals/entertainment. While it is possible to account for such addbacks, there are some drawbacks in doing so.
That’s gonna raise some eyebrows
Most notably, personal expenses are not recognized or accepted acceptable by banks. Because so many business sales are ultimately dependent on SBA loans, disputed addbacks can result in 11th hour problems and issues, where the SBA lender’s interpretation of acceptable addbacks differs from those originally represented in the recast.
Additionally, such personal expenses can also raise red flags among buyers, especially when the sheer number of personal expense addbacks significantly impact the adjusted earnings figure. A large number of personal addbacks can cause a buyer to question the validity of the Seller’s financials, and can result in a Buyer justifiably stepping away from the deal in the due diligence process.
While it’s a common practice to write off some personal expenses to a business, buyers and banks prefer businesses where such practices are kept to a bare minimum; and if possible, not adjusted at all.
A few years ago, I was exploring a possible listing opportunity with an auto repair shop. The owner informed me that he does not have a personal checking account; rather, everything in his personal life is paid for exclusively by his company. Needless to say, I was unable to help this Seller. The moral of the story is to draw a solid line between personal expenses and business expenses whenever possible. Do not rely on the revenues of your business to fund your personal life. Keeping your business finances separate from your personal expenses is an important component of the overall value of your business. The likelihood of a successful closed transaction is maximized when the Seller strives to have clean books.
Contact your “Business Broker Near Me” today.