The Top Five Overlooked Add-Backs When Selling Your Ecommerce BusinessJune 14, 2021 in Blog
You want to sell your ecommerce business. For $500K, $1M, $10M. A business that you have toiled over and spent sleepless nights agonizing about. But do you want to be an owner who leaves $50K, $200K, or $1M on the table giving your buyer what many call “the ignorance discount”?
Of course not. However, in my decades of helping thousands of entrepreneurs sell their businesses, many of them would leave the table piled high with dollar signs after selling.
The biggest mistake I see ecommerce entrepreneurs make when selling their ecommerce business—on their own or through an inexperienced advisor—is not thoroughly and meticulously reviewing their add-backs.
What is an Add-Back?
An Add-Back is an owner benefit, accounting (non-cash), adjustment, or a one-time expense that does not carry forward to the new owner of your ecommerce business. Calculating Add-backs is critical to presenting a true, clear, and accurate depiction of Seller’s Discretionary Earnings (SDE) for potential business buyers. And they are critical in presenting the “true” worth of your business.
Level One Add-Backs
Add-Backs can take many forms. The first form is the “Fairly Obvious”. These are expenses such as:
- Owner’s salary
- Owner health insurance and retirement
- Charitable contributions
- Interest payments
Here’s an example of why this obvious add-back is so important:
If an owner-operator’s business shows a net income of exactly zero dollars, but the owner takes a $300,000 salary, does that mean the business is worth zero? No, you add back the owner’s salary—below the net income line—to the add-back schedule, boosting SDE by $300,000 in this case.
Most businesses owned by the readers of this article are owner-operator businesses. Meaning, when sold to a new owner, that owner will also likely operate the business themselves. Their salary (and yours) is an owner benefit, and therefore, an add-back.
Level 2 Add-Backs
The second form that add-backs take is the “Not So Obvious” shape. These include:
- Owner Payroll Tax Expense and Estimated Income Taxes
- Trademarks, Copyrights, Patents, Logo Designs
- Legal Expenses
- New Bookkeeper Setting up Books in Arrears
- Equipment Purchases
- Personal Miscellaneous.
A critical side-note here:
After reviewing thousands of P&Ls for online businesses, I know that clear financials will help get you in a room with legitimate buyers. You will not sell your business if you can’t get in the room, which is why you need a P&L with a monthly view exported to Excel.
I know, I know – “But my CPA only does my books quarterly”. Fire your CPA.
Hiring a new Bookkeeper to pull data into QuickBooks Online or Xero from prior years, and having it accessible with monthly views is a must for “getting in the room”. This cost for having your business financials cleaned, uncluttered, and transparent doesn’t transfer to the new owner – therefore it is an add-back.
Level 3 Add-Backs
The third and final form of add-backs is in the “Dig Deep and Pay Attention” area.
This category is the most overlooked of the add-backs and can be the most confusing. This category can have sellers leaving hundreds of thousands of dollars on the table. When a seller doesn’t have a complete add-back schedule, we call it an “ignorance discount” for the buyer. Buyers love ignorance discounts!!
These add-backs are 100 percent real and 100 percent necessary to understand.
- Website Redesign
- Cash Back Credit Card Money or Converted Rewards
- Overpaid Relatives or Bookkeepers (when replaced in the TTM)
- Reduced COGS in Trailing Twelve Months (TTM)
- Reduced Third-Party Fees or Packaging Costs in TTM
Let’s dig deep and delve into these sub-categories (just like you should).
The top 5 most overlooked add-backs.
#1 Website Redesigns
The vast majority of online businesses do not redesign their websites annually, so a full or partial add-back should be in place. How partial it is will depend on the history of redesigns. If this is the second redesign in 4 years, you can add back 50 percent of the cost. If you have not done a redesign in 5 years, you may be able to add back 100 percent. These are expenses that do not recur annually.
#2 Masterminds and Related Travel Expenses
But these are business expenses, right? Yes, they are—but the membership to a mastermind does not carry forward in a sale. Nor do the travel expenses or extra few days on each end of the meetup that you and your spouse spend exploring the area.
If the new owner of a business is already a member of a mastermind, or chooses to apply and join the same or a new one, that’s on them. It’s not a required expense, and it does not automatically carry forward.
The two obvious exceptions to this rule are:
- When you attend these meetups and you take your Chief Marketing Officer (CMO) with you, not your spouse. When any employees attend, it is an expense that does not get added back.
- If your business model requires attendance to gain exposure and clients. An example would be if a SaaS company sponsors an event where the attendees may use the product in their day-to-day business. This is not an add-back, as it is considered part of the marketing for the SaaS business.
There are differences between “mastermind meetups” and traditional events, sometimes called trade shows. The Prosper Show, for instance, is an annual event in Las Vegas geared towards entrepreneurs doing much of their business on Amazon. At this event, expert speakers are sharing their wisdom and lots of vendors with booths are answering questions from attendees and attempting to gain them as clients. These vendors cannot add back this expense, even though the entrepreneurs attending might be able to.
Some may argue most entrepreneurs do this and that it is not an add-back, and depending on the circumstances they may be right. In this situation, your Advisor/Broker will need to know much more about your business model and how
expenses may carry forward. With that knowledge, the best decision can be made to instill the most confidence in potential buyers.
#3 Cash Back Credit Card Money or Converted Rewards
Take advantage of cashback or rewards credit cards for your monthly expenses such as advertising. It will put cash in your bank account (and yes, you can add it back even if money is directly deposited to your personal account) and gives you an automatic discount on business expenses. It is a true owner’s benefit. Ignoring cashback money in the add-back schedule costs owners hundreds of thousands of dollars every year. If you are like many, you prefer the benefit of reward points. No worries. All reward points come with a cash value. Simply convert that value (on paper only) to the cash amount per month and add it to the add-back schedule.
#4 Reduced COGS in Trailing Twelve Months (TTM)
If your cost of goods sold went up three months ago by $1.00 a unit, and you sell 500 units a month, you are $500 a month less profitable. If you are under LOI and the buyer says, “Wait, we need to adjust your SDE by $500 a month for the nine months prior to the COGS increase”, they would be correct. Your adjusted SDE would decrease by $4,500 – and overall business value by $4,500, times your list price multiple.
The opposite is also true. If your COGS went down $1.00 per unit three months ago, and you sell 500 units a month, there are nine months x 500 units that are cost savings that carry forward to the new owner of the business. This is absolutely an add-back and overlooked by ecommerce owners almost every time when selling a business on their own.
In this example, you would take the $4,500 (9x$500) times your multiple of say, 3.5, and you would legitimately add $15,750 to the list price of your business. I’ve seen COG reductions in the TTM add more than $150,000 to the list price of a business.
#5: Reduced Third-Party Fees or Packaging Costs
If you are like me, odds are that you had to hustle when you started your first ecommerce business. You probably scraped some cash together for your idea or product and did everything you could just to get the ball rolling.
Over time, you made some changes to cut costs. In my case, I learned more about efficiencies and started outsourcing to VAs, stopped shipping by air, and redesigned the packaging to weigh less and have smaller dimensions for storage.
After launching the business, your implemented ideas and processes for cost reduction are expenses that do not carry forward to the new owner—they are add-backs (if they were put in place within 12 months prior to the listing).
Don’t Overlook the Importance of Add-Backs
There are many more add-backs than those listed here, but they are the most common. The last five are among the most overlooked. The bottom line is that every business is unique, so dig deep, ask questions, and have multiple conversations to capture all the details.
Add-backs should be used to paint the most complete picture of your business. Done right, they will shape an accurate valuation and build trust for the buyer. Overlooking them could result in leaving tens to hundreds of thousands of dollars on the table at closing.
For more advice on how to exit your business profitably, you can find The EXITPreneur’s Playbook on Amazon. Or access the full shareable chapter via the link below.
Joe Valley is a serial entrepreneur, EXITpreneuer, Advisor, and Partner at Quiet Light, one of the top online business brokerage-advisory firms in the world. He has built, bought and sold over a half dozen companies of his own, and helped 1,000s of online entrepreneurs achieve their goals. Joe holds a business degree from Northeastern University, is a Certified Mergers & Acquisitions Professional Advisor, and a frequent guest expert in mastermind groups, on podcasts and at events for online entrepreneurs throughout the world.