Many sellers rely on add backs to increase the attractiveness of profits. If you get carried away with add backs, however, the only thing you may increase is suspicion on the part of buyers and lenders.
All owners have some incentive to minimize perks in order to lower tax liability. Often this is accomplished by writing off certain discretionary expenses – such as owner benefits and one-time costs – as business expenses. Since reducing profits can also reduce appeal to buyers, it isn’t unusual for sellers to reinstate these perks to boost profits prior to putting their limousine companies for sale. These adjustments are known as add backs.
Add backs may be considered legitimate if they are provable and unnecessary for business. For instance, it may be legal for an independent business owner to write off health insurance. Since a new owner can theoretically adjust that expense by opting to pay for insurance personally or choosing a more affordable plan, the cost is considered discretionary – and can therefore be added back. But problems arise when owners get reckless. Here are some common add backs that can cause buyers and lenders to cringe – and potentially cost you the sale.
Let’s say that you use a company vehicle for personal use. Many owners will write off the cost of the car, gas, and maintenance in order to reduce taxable earnings. This may be acceptable if you only use the vehicle to commute to and from work. But if you also routinely use the car to transport clients – a valid business expense – categorizing it as a profit is unfair and dishonest because it distorts the true cost of business operations.
Occasionally, a seller will attempt to add back a salary paid to a family member such as a spouse, sibling, or child when putting a limo service for sale. If this person performs any amount of legitimate work for the company, such as accounting or payroll management, they will need to be replaced after the sale of the business, disqualifying their salary for an add back. Regardless of your relative’s involvement in the company, including a non-employee salary in your cash flow is bound to raise a red flag.
3. “One-Time” Expenses
There are many true one-time business expenses – for instance, paying to replace a stolen limousine or repair storm damage to a storefront. But if you write off accounting or attorney fees two or more years in a row simply because you think a new owner could obtain these services for a lower rate, you’re treading on dangerous ground. Repeating one-time expenses is a sure sign to a buyer that you’re attempting to artificially boost your profit sheet.
Performing occasional work on a business site or office is to be expected. Using the same contractor to remodel your home kitchen, and including those expenses in your business deduction, is not. If a buyer or lender discovers that your business construction costs included a dishwasher and granite countertop, you can probably kiss that deal goodbye.
In summary, add backs can be acceptable if used correctly and sparingly. But business owners hoping to drive up their price by inflating profits may end up deflating their chance of a sale.