EBITDA Add-Backs: The Complete Guide for Acquisition Buyers

When evaluating a small business acquisition, the earnings number you see depends entirely on who calculated it and what adjustments they made. Sellers present one version of earnings. Buyers need to calculate their own. The gap between these two numbers often determines whether a deal makes sense.

This guide walks through the key earnings concepts (Reported EBITDA, Seller's Discretionary Earnings (SDE), and normalized Adjusted EBITDA) and explains how to evaluate the add-backs that transform one into another.

Starting Point: Reported EBITDA

Reported EBITDA is calculated from the company's financial statements before any normalization adjustments. Many small businesses do not explicitly report EBITDA, so it is often reconstructed from the income statement rather than presented as a formal line item. It's calculated as:

Net Income + Interest + Taxes + Depreciation + Amortization = Reported EBITDA

This is the "book" EBITDA: what the accounting records show. For a small business, Reported EBITDA often understates the true earning power because it includes expenses that won't continue under new ownership (like excess owner compensation) and one-time costs that distort the picture.

Reported EBITDA is the starting point, but rarely the number that matters for valuation.

EBITDA is not cash flow. It does not reflect working capital needs, capital expenditures, or owner-level taxes, all of which materially affect economic earnings.

What Sellers Present: Seller's Discretionary Earnings (SDE)

When a business goes to market, sellers typically present Seller's Discretionary Earnings (SDE), a recast earnings figure that adds back the owner's total compensation and benefits to Reported EBITDA.

The calculation:

SDE is typically derived from reported earnings by adding back owner wages or guaranteed payments (and related payroll taxes), owner benefits and personal expenses run through the business, one-time or non-recurring expenses, and other discretionary items.

SDE represents a seller-defined view of total earnings before paying for a replacement operator. It is commonly used as a marketing and reference metric in smaller owner-operator transactions, but it should never be accepted at face value. Buyers and lenders must always vet, document, and normalize SDE to reflect realistic post-close operations.

Expenses added back to calculate SDE:

• Owner compensation (wages, bonuses, or guaranteed payments, plus related payroll taxes)
• Owner benefits (health insurance, retirement contributions)
• Owner perks (personal vehicle, cell phone, club memberships)
• One-time/non-recurring expenses (legal settlements, moving costs, etc.)
• Discretionary expenses the owner controls that wouldn't continue under new ownership
• Other pro forma adjustments

The catch: Sellers have strong incentives to maximize SDE. The add-backs they claim may be aggressive, undocumented, or include expenses that actually need to continue under new ownership.

SDE vs. Adjusted EBITDA: What's the Difference?

Adjusted EBITDA reflects normalized earnings after accounting for realistic post-close operations, including a market-rate salary for whoever will run the business, whether that is the buyer or a hired manager.

The key difference:

Example: The current owner takes $350,000 in total compensation. A qualified general manager would cost $120,000.

• SDE adds back the full $350,000
• Adjusted EBITDA adds back only $230,000 (the excess above market rate)

In SBA acquisitions, SDE is often referenced early in discussions, but lenders underwrite to normalized cash flow. In practice, this lender-adjusted earnings figure aligns much more closely with Adjusted EBITDA than with headline SDE.

The Buyer's Goal: Your Own Normalized EBITDA

Here's where things get real. The seller presents their version of SDE or Adjusted EBITDA with their proposed add-backs. The buyer's job is to:

1. Verify each add-back with documentation
2. Challenge aggressive adjustments that don't hold up
3. Identify additional adjustments the seller may have missed (both positive and negative)
4. Arrive at a defensible normalized EBITDA that reflects what the business will actually earn under new ownership

Sellers' add-backs are frequently overstated. A seller might claim $400,000 in SDE, but after a buyer's analysis, the supportable number might be $320,000. On a 4x multiple, that's a $320,000 difference in enterprise value.

Common Add-Backs (And When They're Legitimate)

Owner Compensation and Benefits

The biggest adjustment category. Legitimate when properly documented.

Legitimate: Owner takes $300,000; market-rate manager costs $100,000. The $200,000 difference is a valid add-back for Adjusted EBITDA.

Questionable: Owner claims their role only requires $80,000 in market comp, but the position actually demands senior expertise worth $150,000. Understating replacement cost inflates the add-back.

Owner Perks and Personal Expenses

Expenses that flow through the business but serve the owner personally.

Common examples:

• Personal vehicles ($800-1,500/month)
• Family cell phone plans ($200-400/month)
• Country club memberships
• Travel that's more vacation than business

The test: Will the new owner or other employees bear these expenses to sustain ongoing operations, or are they truly removable?

One-Time Professional Fees

Lawsuits, M&A advisor fees, major consulting projects: expenses that don't recur annually.

Legitimate: A $75,000 legal settlement from a slip-and-fall case two years ago. Assuming the underlying issue is resolved, this won't repeat.

Questionable: "One-time" consulting fees that appear every year under different project names. That's not one-time; that's how the business operates.

Related Party Transactions

Payments to family members, rent to owner-controlled entities, supplier arrangements with companies the owner has stakes in.

Red flag example: Seller pays $8,000/month rent to their personal LLC when market rate is $5,000. The $36,000 annual difference is a valid add-back, assuming the real estate is not included in the transaction and the business will lease the property post-close.

Non-Recurring Revenue Adjustments

Sometimes adjustments go the other direction. If revenue included a large one-time contract that will not repeat, the incremental profit contribution from that contract should be removed from normalized earnings, not just the revenue itself.

Example: A government contract worth $200,000 ended last year. Leaving this in overstates what a buyer can expect going forward.

Add-Backs That Should Raise Red Flags

Watch for these red flags in seller financials:

Aggressive normalization of bad years: "Revenue was down because of [excuse], so we're adding back to normalize." Unless there's documented evidence the issue is resolved, this is wishful thinking, not analysis.

Stacking add-backs on thin justification: Each individual add-back might be small, but when 15 adjustments combine to double EBITDA, the cumulative effect deserves extra scrutiny.

Add-backs without documentation: "Trust me, that was a one-time expense" isn't evidence. Legitimate add-backs come with invoices, contracts, or clear explanations.

Maintenance capex disguised as one-time: Replacing aging equipment is a cost of doing business. If the "one-time" equipment purchase happens every few years, it's really recurring capex that should not be added back.

Capitalization policy games: Expenses that are improperly capitalized or deferred to inflate EBITDA should also raise red flags.

How Add-Backs Affect Your Deal

Valuation Impact

Most small business acquisitions use a multiple of Adjusted EBITDA or SDE for valuation. If the seller's add-backs increase earnings by $150,000 and the deal is priced at 4x, that's $600,000 in enterprise value, coming directly out of your pocket if the add-backs don't hold up.

SBA Loan Qualification

SBA lenders calculate debt service coverage using a lender-defined normalized cash flow that reflects post-close operations. Overstated add-backs might help you qualify for a loan you can't actually afford to service. The bank doesn't care what the seller claimed; they care about cash flow.

Post-Acquisition Reality

Every unsupported add-back is a post-closing surprise waiting to happen. Buy a business expecting $600,000 in earnings that only generates $450,000, and that 25% shortfall comes directly from your returns.

What This Means For Your Deal

Before accepting any add-back at face value:

1. Request documentation for every adjustment over $10,000. Invoices, contracts, payroll records, whatever supports the claim.
2. Calculate the "haircut" scenario. What happens if 30% of proposed add-backs don't materialize? Can the deal still work?
3. Get independent verification. A quality of earnings analysis validates add-backs with professional skepticism.
4. Negotiate protections. Use escrow, holdbacks, earnouts, or specific indemnities for clearly defined adjustments that may not hold post-close.
5. Watch for patterns. If multiple add-backs rely on the same questionable logic, the entire adjustment schedule may need reworking.

Key Takeaways

• Reported EBITDA is the starting point: earnings before interest, taxes, depreciation and amortization (straight from the books with no adjustments)
• Seller's Discretionary Earnings (SDE) adds back owner compensation, one-time expenses, and discretionary costs; useful for understanding total cash available to an owner-operator
• Adjusted EBITDA reflects normalized operations after paying a realistic market-rate salary and serves as a defensible proxy for sustainable earnings in buyer and lender underwriting
• Never underwrite to SDE: it assumes the buyer works for free. Always value based on normalized Adjusted EBITDA that includes a market-rate salary
• Sellers' add-backs are frequently overstated: the buyer's job is to verify, challenge, and arrive at a defensible normalized number
• Documentation is everything: Legitimate add-backs come with invoices, contracts, and clear explanations