The Power of EBITDA Add-Backs: Maximizing Your Staffing Company’s True Value
Selling your staffing business requires a deep understanding of various financial metrics and their implications to your outcome. Among the key financial metrics that play a significant role in Mergers and Acquisition (M&A) transactions is EBITDA or Earnings Before Interest, Taxes, Depreciation, and Amortization.
It’s helpful to first understand what EBITDA is. EBITDA is a fundamental financial indicator used to evaluate a company’s profitability and operating performance and the key metric used when valuing a staffing business. However, to gain a comprehensive understanding of a company’s true profitability, it’s essential to also consider adjustments or add-backs (hereinafter referred to as add-backs) to EBITDA. This article will provide you with insights into what EBITDA add-backs are, how they impact your company’s valuation, and how potential acquirers view them.
How EBITDA is Calculated
EBITDA is calculated by adding back interest, taxes, depreciation, and amortization to your company’s net income. The formula for EBITDA is:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
The Role of EBITDA in Mergers and Acquisitions
EBITDA directly influences the valuation of a company as potential acquirers apply a multiple to a target company’s EBITDA. The resulting amount reflects how much they are willing to pay for a company or their purchase price. In a hypothetical example, if a staffing company is earning $5 million in EBITDA, a potential buyer may value the business at a 5x multiple which equates to a $25 million valuation. In other words, a potential buyer would be paying $5 for every $1 of EBITDA generated. The higher the EBITDA, the higher the purchase price.
What are Add-Backs in M&A Transactions
Add-backs are financial modifications made to a company’s EBITDA to provide a more accurate reflection of a company’s true financial performance. The purpose of add-backs is to eliminate or strip out certain expenses (or in some cases income items) that are considered either one-time, non-recurring or extraordinary in nature from a company’s historical, current and projected income statements. These expenses are then “added-back” to EBITDA to arrive at a more realistic representation of the company’s profitability. In other words, if certain expenses are added-back, a potential buyer should expect that it will not incur those expenses following a transaction. The result is a higher EBITDA which translates into a higher valuation and purchase price.
Taking our hypothetical example from before, every $1 of add-backs leads to an additional $5 in purchase price.
Common Examples of Add-Backs in Staffing Transactions
- Owner-related expenses, such as compensation and benefits or personal expenses charged to the company
- Non-recurring expenses, such as technology implementation costs or legal expenses from a lawsuit
- Non-operating income or expenses, like gains from asset sales or extraordinary losses
- Charitable donations and discretionary expenses
How Buyers and Sellers Approach Add-Backs
It should be noted that potential acquirers do not accept or provide credit for add-backs related to potential synergies they are able to take advantage of following a transaction. For example, a potential acquiror may reduce costs by integrating the back office of the acquired company into the buyer’s larger infrastructure. A potential buyer would not consider this a valid add-back.
Disputes often arise during the M&A process regarding the legitimacy of add-backs. Sellers must be prepared to present add-backs transparently and with strong supporting documentation to defend their rationale. Demonstrating the legitimacy of adjustments can build trust and facilitate smoother negotiations. Taking the approach of seeing what sticks creates doubt and results in a loss of credibility with potential buyers.
Buyers, on the other hand, approach add-backs with a critical eye. Recall, they are paying a multiple of every dollar added-back to EBITDA. Because of this, they dedicate considerable time and effort to fully understand the rationale for every add-back proposed to verify and validate the legitimacy of each.
The Need for Expert Advice
Working with an experienced M&A advisor who thoroughly understands how add-backs work in staffing company transactions is crucial for sellers for several reasons:
An experienced advisor can help identify and justify add-backs effectively by preparing the necessary documentation and explaining the legitimacy of these adjustments to potential acquirers. By doing so, they reduce the chances of disagreements and delays, resulting in a smoother negotiation process and an increase the sellers outcome.
Clear, accurate, and well-supported add-backs are essential to maintaining credibility with potential acquirers. An advisor who understands add-backs can help sellers present these adjustments transparently and convincingly, building trust and confidence in the deal.
Every M&A transaction is unique, and the nature of add-backs may vary from one deal to another. An advisor can tailor their approach to your specific circumstances, considering the industry, market conditions, and the buyer’s perspective.
A significant amount of time, money, and effort goes into completing an acquisition from both the buyer’s and seller’s end. Because of this, buyers tend to be very skeptical and will highly scrutinize a company’s customer relationships and agreements when diversity certifications are involved.
Ultimately, add-backs require transparency and clear documentation to justify their inclusion in the financial statements, as they can significantly impact the purchase price and deal negotiations. Properly understanding, justifying, and presenting add-backs is crucial for a successful M&A transaction.
Working with an M&A advisor who is well-versed in staffing transactions and understands how to identify and negotiate add-backs is essential for sellers seeking to maximize their outcome in a sale. At Momentum Advisory Partners, we provide expert guidance to help you navigate the complexities of an M&A transaction, ensuring a smooth sale process. We have over 15 years helping founders of staffing companies capitalize on their life’s work.