What You Need To Know About SDE Add Backs

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When determining the selling price of your Amazon FBA you should start with calculating your SDE. Seller Discretionary Earnings (SDE) is the magic formula that will give you an understanding of the value of your business and what is a fair price to ask.

The formula for SDE is as follows:

SDE = Net Profit + Add Backs

What are Add Backs?

Add backs are expenses that won’t be included in the buyer’s PL statement. They’re expenses that will be added back to the business’ profit.

Table of сontents:

Why are Add Backs important?

Add backs play an important role in a sale of an Amazon FBA business; they are expenses the previous owner had, that won’t be an expense to the new owner. These expenses play an important role when determining the value of a business because they increase its net profit – and can significantly boost its final sale price.

In short, not understanding applicable add-backs is the same as leaving money on the table.

How do Add Backs work?

Add backs function in service of the Amazon FBA seller, and significantly increase the sale price of the business. They play a crucial part when determining the SDE (Seller’s Discretionary Earnings), and they help sellers negotiate a better deal.

What types of add backs can I apply?

Add backs fall into four categories, as follows:

1. Personal expenses

It’s normally advisable to refrain from using business funds for personal expenses. However, it’s very common for owners of small, closely-held businesses to pay for some personal expenses with business funds.

Factors like a business owner’s car repairs or personal travel can often be added back. But how do you know which expenses are legitimate?

The personal expenses that qualify must be one time expenses that only show up on an income statement only one time. If the expense recurs year after year, it won’t qualify. Likewise, expenses that are expected to continue after a business’ sale won’t qualify. It’s extremely inadvisable to try to be sneaky by adding back expenses that will not go away under a business’ new management.

Many of these expenses will fall under the category of ‘discretionary’ add backs.

2. Business Expenses

Some business expenses can be added back, but you must deal with each individually.

One-off business expenses that were never repeated are the prime candidates – examples include marketing expenses that did not pay off, a failed project that was scrapped before any results were produced, or hiring an accountant to sort out your financial statements. But expenses such as a short-term bad hire, or professional fees for services that remained undelivered, could also qualify.

Of course, these kinds of business expenses are unique, so they should be approached as such. Consult with a financial professional if you’re not sure whether a particular business expense qualifies for being added back.

3. Owner’s compensation/salary

Many businesses are run closely by the owner. In these cases, owners will often pay themselves very large salaries – and perhaps sprinkle some generous bonuses on top. This is especially common for highly profitable small businesses.

While what’s described above is completely legal and ethical, most buyers would not want to pay that same level of compensation to their new executive suite. So, the difference between the old owner’s salary and the reasonable salary of the new president is the add back.

One important thing to remember is that this add back can go both ways. For example, if the baseline for the position is $100,000 but the old owner paid themselves $300,000, the add back could be $200,000. But if the new owner only pays the new owner $50,000, instead of the baseline $100,000, the add-back would be a negative $50,000.

If there are two owners, their compensation will be combined.

3. Lawsuits, settlements & severance

While these expenses are far less common than the others we’ve gone over, they are still worth noting.

Severance payments and lawsuit settlements may be a cause for concern for buyers. But as add backs, they are completely legitimate. The only exception to this rule is if lawsuit and settlement expenses were a common occurrence for your business.

For these expenses to be considered as add backs, it’s important that paying them is a one-time event.

An Add-Back checklist

Add backs normally fall into at least one of the following categories.

  • Discretionary spending: Discretionary spending doesn’t normally contribute to the business’ operations. Business entertainment expenses and excesses such as above-market compensation normally qualify. Most of the above examples include non-discretionary spending.
  • Non-recurring expenses: The add backs you use mustn’t be regular expenses. Working capital expenses that are expected to continue with the business’s new owners cannot be added back.
  • Non-operational: On that same note, you don’t add back most operational expenses. Add backs that aren’t operational will naturally not be expected expenses for the future.

Is amortization an Add Back?

Amortization is a non-cash expense, which means it must be added back to net earnings. Business owners may face confusion as to whether amortization is an add back. The short answer is that it is.

Depreciation and amortization are used to expense things like property, equipment, and even capital investments. But amortization is also commonly used to expense software and intellectual property of all types. This is why they are a part of the EBITDA model, and why so many tech and research companies use it in their early stages and before selling.

You can calculate EBITDA addbacks for your Amazon FBA business before the sale. But it’s important to know what constitutes a legitimate add back. There are often plenty of large, irregular transactions that a small business owner could look to. Small businesses that are held closely by their owners often have peculiarities such as high presidential salaries that well exceed market expectations. This can often qualify as a good reason for an add back.

Key takeaway

Every business is a different story. And the older the business gets, there are more and more specifications and unique details to check.

However, to make the most of your sale, you must start by maximizing the profits you can make using industry-standard calculations that include all the qualified add-backs. Understanding addbacks makes the selling process more understandable and more profitable than it would be without this knowledge.

Buyers will use similar methods to assess your business. Of course, they will often opt to pay you less when they can. So, use the methods we’ve covered to ensure that you get the greatest possible reward for your hard work.

Want to know the current value of your business? Contact Us and we will send you a free business valuation in 24h or less!

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