A Practical Guide for Business Owners Preparing to Sell
If you are considering selling your business — now or in the next few years — understanding add-backs is critical.
Many owners believe they have significant discretionary expenses that will increase the value of their company. Sometimes they’re right. Often, they’re surprised by what buyers and SBA lenders will — and will not — accept.
Ultimately, valuation is driven by one number:
Seller’s Discretionary Earnings (SDE).
And how that number is calculated matters.
What Is Seller’s Discretionary Earnings (SDE)?
SDE represents the total financial benefit available to a full-time owner-operator.
It typically includes:
- Net profit
- Owner’s salary*
- Interest
- Taxes
- Depreciation (though sometimes offset by CapEx requirements)
- Amortization
- Legitimate add-backs
*In cases where multiple owners are taking a salary (for example both spouses) and the business is being sold to one buyer, typically just one salary can be added back. The other seller position/role may need to be filled by a new hire.
Add-backs are adjustments made to reflect the true earning power of the business under normalized ownership. Not every expense qualifies. This is where the concept of legitimate add-backs becomes important.
What Buyers and SBA Lenders Typically Allow
When a transaction involves SBA financing — which many small business sales do — lenders follow strict underwriting standards. They focus on historical, provable cash flow.
Below are add-backs that are commonly accepted when properly documented.
Owner Compensation
The owner’s salary, payroll taxes, and discretionary distributions are typically added back in an SDE model.
In fact, paying yourself appropriately through salary — rather than running personal expenses through the business — is the cleanest and most defensible approach. Run your business like a real business.
If there are two owners (for example, partners or spouses) and both will be leaving after the sale, generally only one salary will be fully added back. It is not reasonable to expect a new buyer to assume the full roles of two people.
If one owner works part-time (such as bookkeeping), there may be an offset to reflect the cost of replacing that function at market rates.
Interest Expense
Debt service from existing loans is added back because the buyer’s financing structure will differ.
One-Time, Non-Recurring Expenses
Examples may include:
- A one-time legal settlement
- An isolated, unusual expense
- Storm or casualty-related repairs
- True relocation costs
If the expense occurred only once and is unlikely to recur, it may qualify.
Clearly Personal Expenses
Documented personal expenses run through the business — such as a vehicle for a spouse not involved in operations — may qualify.
However, mixed-use expenses receive careful scrutiny. Gas, travel, meals, and entertainment are frequently discounted if it cannot be clearly determined which portion was personal versus business-related.
Excess Family Payroll
If a family member is on payroll but not actively involved, or is paid significantly above market rates, the excess portion may be adjusted.
That said, this area receives significant scrutiny. Banks prefer clean payroll structures. If this is occurring and you plan to sell soon, it is wise to correct it now.
Above-Market Rent
If the seller owns the building and charges rent above fair market value, the excess may be adjusted — typically supported by a market rent analysis.
Owner Life Insurance
If the policy covers the owner personally and the owner is leaving, the expense typically goes away. However, if the SBA loan requires life insurance, that requirement may offset this credit.
Bad Debt
This may qualify if it is one-time, unusual, and not representative of regular business operations.
Important: Banks will always require documentation and proof that these expenses were not related to ongoing business operations.
What Is Commonly Rejected
This is where expectations and underwriting standards often diverge.
Hypothetical Future Improvements
Statements such as:
- “A new owner wouldn’t spend this much on advertising.”
- “Payroll could easily be reduced.”
- “I intentionally overstaff.”
- “All you need to do is advertise or hire a salesperson.”
- “I turn away a lot of work.”
These are projections — not historical add-backs. Banks underwrite based on performance, not potential.
Recurring Expenses Labeled as “One-Time”
If an expense appears consistently — even annually — it is considered recurring.
Required Operating Expenses
Meals, travel, vehicles, software, insurance, and payroll necessary to operate the business are not discretionary, even if the owner personally benefits from them.
Unreported Cash Revenue
If income is not reflected on tax returns, it cannot be used for SBA underwriting.
While this may be tempting for cash-heavy businesses, it significantly reduces on-paper profitability and raises credibility concerns. Banks do not like it. Buyers do not like it. The negative impact on sale value almost always outweighs any short-term tax savings.
Necessary Capital Expenditures
Equipment replacement and maintenance are economic realities and are not treated as discretionary.
Seller Distributions
This can cause confusion for owners valuing their business for the first time. Seller distributions represent profit already reflected in the business’s bottom-line net operating income. Adding them back would count the same money twice.
What Falls into the Gray Area?
Personal Travel
It must be clearly demonstrated that travel is not required to operate the business. If you are currently running personal travel through the business and plan to sell for maximum value, consider eliminating it now.
Owner Personal Auto
As with travel, it must be proven that the vehicle is not necessary for operations.
For some businesses, this is clear. However, a pickup truck used daily for estimates and materials would likely remain a business expense for a new owner.
If it is a spouse’s vehicle, perhaps. If it is yours and used regularly for work, likely not.
Personal Health Insurance
This is often misunderstood. Many banks will not allow this as an add-back because a new owner will likely incur a similar expense. While arguments can be made otherwise, most lenders tend to disallow this adjustment.
Why This Matters for Valuation
Most small businesses trade between 2.0x and 4.0x SDE, depending on industry, size, and risk profile.
If $100,000 in add-backs is removed during underwriting and the business trades at a 3x multiple, that represents a:
$300,000 reduction in value.
Realistic, defensible financials directly protect your valuation.
A Common Misconception
It is true that many small business owners run personal expenses through their company.
However, lenders evaluate add-backs based on:
- Documentation
- Consistency
- Operational necessity
- Likelihood of recurrence
If an adjustment cannot be clearly supported, it will likely be reduced or eliminated during due diligence.
Planning Ahead
Credibility carries more weight than creativity.
Businesses that sell for the highest multiples and best terms have clean books — the cleaner, the better.
If you anticipate selling within the next five years, meet with your accountant and shift to a strictly “by-the-book” financial philosophy. It will pay off in the long run.
Now is the time to:
- Separate personal and business expenses
- Reduce discretionary spending
- Maintain organized, transparent financial records
- Normalize payroll structures
- Think of your business as a true business, not a vehicle to reduce personal taxes
Clean financials increase buyer confidence, improve SBA approval likelihood, and lead to higher valuations and sale prices.
Add-backs are not about stretching numbers.
They are about accurately representing the true earning power of your business — in a way buyers and lenders will accept.
If you would like to understand how your business would be viewed through an SBA underwriting lens, I am happy to have a confidential conversation and walk through it with you.
Patrick Bombardiere
Owner-Partner – Transworld Business Advisors
303-929-9219
patrick@tworld.com