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18 Sep Understanding Add Backs: A Comprehensive Guide for IT Services Business Owners

Posted at 15:34h in M&A by
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Inspired by Shoot the Moon Podcast episode #216 – “You Can’t Add Back What You’re Still Doing. A CEO’s Guide to Clean EBITDA” Listen to it –>

“All deals in IT services are priced on a multiple of EBITDA, so every qualified add‑back has a multiplicative effect.” — Mike Harvath, Revenue Rocket CEO

When it’s time to sell, the value of your managed service firm (MSP) or other tech‑enabled services firm, nothing moves valuation faster than a defensible set of EBITDA add‑backs. Get them right and you can add seven figures to your exit; get them wrong and buyers will question your credibility and haircut your multiple.

1. The Golden Rule

“If it stays, it pays. If it goes, it grows.” — Ryan Barnett, Revenue Rocket CMO & EVP 

Only costs that vanish post‑close belong on your add‑back schedule. If the buyer (or you, if you’re sticking around) must keep funding the expense, it stays on the P&L.[/vc_column_text]

2. What Usually Qualifies

Legitimate Add‑Back Category Examples Why It Works
Owner lifestyle & perks personal vehicle lease, sports box tickets Personal benefit disappears when owner exits
Above‑market owner salary $300k salary reduced to $175k replacement CEO Add-back the difference
One‑time professional fees M&A, legal, or estate‑planning costs Non‑recurring and tied to the transaction
Extraordinary events PPP‑loan forgiveness, flood remediation Time‑boxed, outside normal ops

Distributions ≠ Add‑Backs

Mike’s reminder: “Owner distributions sit on the balance sheet—they never hit the P&L, so you can’t add them back.” (Find Mike’s explanation on this on the podcast episode, 19:01–20:43)

Many founders pay themselves primarily via owner distributions because it’s tax‑efficient. Perfectly legal—but those dollars never flow through operating expenses, so they never reduce EBITDA in the first place.

Mike’s on‑air warning was blunt:

“I see sellers try to add back the above‑market portion of a distribution that never hit the P&L. Buyers won’t allow it because there’s literally nothing to reverse.” (19:20)

Take‑aways →

  • Only W‑2 salary that actually lands on the P&L can be adjusted. Want credit for excess comp? Run it through payroll at least a year before you market the company.
  • Treat distributions like dividends, great for cash flow, irrelevant to EBITDA.
  • Trying to “double‑dip” by labeling distributions as add‑backs raises red flags about your financial savvy (and integrity).
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3. Gray Areas

Not every cost fits neatly into a “yes” or “no” box. Mike, Matt, and Ryan spent a good chunk of the episode unpacking these edge cases, expenses that might vanish post‑close but just as easily could stick around. Before you stake your valuation on a borderline item, run it through the questions below.

Expense Type Key Questions Likely Outcome
Staff Reductions Were roles truly redundant, or cut just to dress up EBITDA? Add‑back only if headcount stays reduced post‑sale
Marketing program cuts Can growth targets be hit without the spend? Buyers re‑insert spend if growth requires it
Rent & real‑estate Is sub‑tenant locked in? Are you charging above‑market rent to your own LLC? Add‑back excess rent; be conservative on sub‑leases
Bonuses & profit‑share Is plan ongoing or one‑off? Recurring plans stay; one‑time “thank‑you” bonuses may qualify

4. What Buyers Won’t Accept

  • Core systems they’ll still need — e.g., ConnectWise, Kaseya, CRM/ERP (22:10–24:21)
  • Synergy savings the buyer creates (duplicate licenses, G&A consolidation) (24:21–26:12)
  • Personal extravagances that signal poor judgment: private jets, large car collections, even a mistress’s house (35:09–37:43)

If an item makes the buyer question your ethics or business acumen, leave it out.

5. Five‑Step Add‑Back Playbook

  1. Start 12–24 months out. Cleaner books > creative accounting.
  2. Tag every candidate line item with invoices + one‑line rationale.
  3. Bridge the numbers: GAAP or tax P&L → EBITDA → Adjusted EBITDA.
  4. Stress‑test with a third‑party advisor like Revenue Rocket, so buyers don’t “Photoshop” your EBITDA for you.
  5. Stay transparent. Ryan: “Buyers will redo your add‑backs, that’s reality. Over‑inflated schedules erode trust.” (33:23–35:09)

6. Due‑Diligence Survival Kit

  • Maintain monthly, accrual‑basis financials.
  • Keep backup docs (invoices, contracts, lease agreements) in a VDR.
  • Separate owner distributions from salary; only P&L items can be added back.
  • Be ready to defend each line in a live Q&A with the buyer’s finance lead.

Ready for a gut‑check on your own add‑back schedule? Email info@revenuerocket.com to set up a no-obligation introduction call.

Run a high‑margin business first; fine‑tune add‑backs second. That’s the surest path to a premium exit.

Prefer to listen? Check out our podcast episodes on add-backs:

  • Episode 216: You Can’t Add Back What You’re Still Doing: An IT Services CEO’s Guide to Clean EBITDA. Listen now >>
  • Episode 141. Add-Backs 101. Listen now >>
  • Episode 23: Understanding the Impact of Add-Backs.  Listen now >>