Few areas of a business acquisition generate more discussion than seller add-backs. Some are entirely legitimate. Some require judgment. Some should never have been added back in the first place.

A Quality of Earnings analysis should not simply accept a schedule of adjustments because it was included in the offering memorandum or provided by the seller. Each material adjustment should be evaluated on its own terms. Was the expense actually incurred? Is it truly nonrecurring? Is it discretionary? Will the buyer incur the expense after closing? Is there adequate documentation? Does eliminating the expense create an unrealistic picture of future operations?

Consider something as simple as owner compensation. The seller may add back the owner’s entire salary. But if the owner actively manages the company, someone will still have to perform those duties after the acquisition. The appropriate adjustment may therefore involve replacing the seller’s compensation with an economic replacement salary—not eliminating the expense entirely.

The same principle applies throughout the analysis. An add-back should not increase earnings simply because someone labeled it an add-back. It should increase earnings only when the economics support the adjustment.

Experience Matters Most.