What are examples of non-recurring add-backs and why do we use add-backs in valuation?
Answer
So normally, this question will just be the first part and you can weasel your way into passing it just by listing some examples. But, our thesis is to show an actual understanding of source material so that’s why we’re adding the why in. Tack it on to the end of your answer.
So regarding the examples part:
- Asset Write Downs
- One-Time Legal Expenses
- Disaster Expenses
Management Salaries (assuming they’re paying themselves way above market pay)
The theme here is any expense that is not core to operations of the business and does not reflect the true efficiency of the business.
I gave you a bit on the why above, but a nice way to explain it is:
One-time expenses that are not core to the business are, well, one-time. They shouldn’t recur anymore so it would be unfair to burden EBITDA in valuation, given they’re not a part of the go-forward plans of the business, which is what an acquirer should be looking for.
On the management salaries. If a CEO is paying himself $5mm a year, and the average price for a CEO in this market, at this scale, is $1mm then you would add-back $4mm. Either the acquiring entity is going to axe the CEO or dock the life out of his pay to get closer to market.
Why this matters to bankers
Add-backs are often a point of contention in a pretty funny way. The banker wants as many add-backs as they can get and a buyer wants as little. Why? Add-backs are non-recurring expenses that should not affect valuation since they’re not included in the forecast. This means that they raise the EBITDA base that a buyer will bid off of. We’ll go through some examples below.