The Do’s and Don’ts of Add backs! (Knowing what to fight for) Our BIG disclaimer! The following examples are how current lenders/underwriters view add backs when being considered in their cash flow analysis. These are views compiled by Diamond Financial but are not opinions made by Diamond Financial. Many of the current, aggressive lenders were included in these compilations. Unlike some lenders, the lenders we use only make money by approving and closing loans as opposed to being paid for reviewing them and securing banking deposits. We live where you live, we only make money by funding deals. Know who’s on your side when truly evaluating your lending options.

Cost of Good Sold Item #1 Personal home items– This category is NEVER an add back and here’s why: 1) The IRS considers this as the “Cost of Goods Sold” and only the cost of “GOODS” sold to produce the revenues stated above. 2) The more you prove there are additional items in this number, the more you prove the seller is dishonestly submitting his tax return information to the federal government—We NEVER want to do this. 3) Proving the actual amount of items utilized in the business operations is usually very difficult. Stay away from this one understanding what you could be exposing on the sellers side.

Discontinued Advertising Item #2 Discontinued Advertising is “typically” not considered an add back and here’s why: 1) No one can prove or disprove the actual effects that this advertising had/has or will have on sales. Customers may have seen the ad many times (the 9 rule) and have not chosen to call until they needed the actual service your client provides and then finding a phone number online as opposed to the method of advertising. 2) May be considered if the cost was for an item such as sponsoring a children’s baseball team and most of the businesses clients come from other states, as an example. 3) If the advertising add back was for additional years then it brings into question the lack of management skills the seller possess if in fact this is an add back. Meaning, if the seller unwisely ran the business over the last three years and spent money on unproductive items. Depending on the amount, not typically worth fighting for.

Amortization Item #3 Amortization is “typically” considered an add back and here’s why: 1) Seller specific loans, leases and other financing products used to secure the business are typically being paid off or secured by the seller only and are not being assumed by the buyer. 2) Items to be aware of in this category are any bank charges for credit card processing that may continue, leases on vehicles, equipment or other assets being assumed by the buyer and NOT being paid off prior to closing. 3) We will deduct for our buyers financing considerations after determining the total SDE for the business and at a later point. Almost always an add back excepted by all lenders!

Personal Cell Phone Item # 4 Personal cell phones are NOT “typically” considered an add back and here’s why: 1) In all reality, do you truly believe the buyer will not posses a cell phone? Or consider his bill as a company expense? 2) Think about the business and the cell phone actual usage. Do they have any staff they contact on their cell phone? Is the seller out of the office at all and uses the phone to conduct any business? 3) We could possibly prove this by reviewing the last six months of calls for the seller and showing that his cell phone was not in any way used to conduct or contact his business. Chances are, we should let this one go. 4) We can also consider family members that do not work in the business that are supplied cell phones.

Depreciation Item # 5 Depreciation is “typically” considered an add back and here’s why: 1) It’s a non-cash event that allows for the deduction of revenue as reported to the IRS for tax purposes. 2) Any concern on this item will be related to the “Actual Usable Life” of the equipment or assets being depreciated. 3) We typically add this back and look for the underwriters guidance on any changes to this.

Family Health Insurance Item # 6 Health insurance for family members is “typically” considered an add back and here’s why: 1) If it is provided to the seller’s family members that are either leaving the business after the closing, or not working in the business currently. 2) NEW CONCERN Current lending guidelines now look at the seller’s personal health insurance as a required cost of doing business and MAY NOT be considered an add back unless your buyer can prove he currently has benefits and that they will continue (possibly through a spouse’s job). 3) Leaving the buyer with no health insurance is no longer an option if the seller is paying his out of the business cash flow.

Interest Expense Item # 7 Interest is “typically” considered an add back and here’s why: 1) Seller specific loans, leases and other financing products used to secure the business are typically being paid off or secured by the seller only and are not being assumed by the buyer. 2) Items to be aware of in this category are any bank charges for credit card processing that may continue, leases on vehicles, equipment or other assets being assumed by the buyer and NOT being paid off prior to closing. 3) We will deduct for our buyers financing considerations after determining the total SDE for the business and at a later point.

Wife’s Personal Vehicle Item # 8 Personal Vehicle’s are “typically” considered an add back and here’s why: 1) When considering this add back an underwriter looks at whether this vehicle is used for the business and by the business to produce the gross revenues as reported. If this vehicle is not critical to sales then it is usually considered an add back. 2) What is NO LONGER accepted as an add back by lenders as of 2012 are costs related to vehicles. Meaning: Fuel and repairs are NO longer accepted as add backs as proving them is very difficult. 3) We can ONLY add back actual “Lease or loan payments” on that vehicle providing we have proof that the payments were being paid from the business accounts.

Lease Payments Item # 9 Lease payments Are “typically” considered an add back and here’s why: 1) If it is equipment that the seller will be paying off at the closing then this expense will not be realized in future costs. 2) The only concern on this item will be related to the assuming of these leases that WILL continue to the buyer. 3) If at closing we are acquiring the business assets free and clear of liens and encumbrances then we should always explore all prior years relevant to determine any additional lease payment add backs.

Lodging and travel Item # 10 Lodging and Travel is NOT “typically” considered an add back and here’s why: 1) It is very difficult to determine what part of travel is required as almost all business show some travel as an expense. 2) In regard to lodging and adding it back. The question will be asked if there is any ongoing training in any way for the owners or staff, most businesses have some and if that’s the case, proving this one gets tougher. 3) This is usually a small number and trying to prove this is not typically worth it.

Meals and Entertainment Item # 11 Meals and Entertainment is NOT “typically” considered an add back and here’s why: 1) It is understood that owners typically dine out and expense the meal through this category, BUT some meals are with business acquaintances, employees, clients or persons that have some relation to the business. Determining which ones do and do not is just not possible from a lenders perspective. 2) Also included many times are office lunches, meeting food and drink and other ongoing legitimate business expenses. Actually separating these and claiming the new owner will have none is difficult.

Officer Salary Item # 12 Officer Salary is “typically” considered an add back and here’s why: 1) It’s specific to the seller and the buyer will require his own. 2) Any concern on this item will be related to multiple officers and the job positions and contributions of each. It is difficult to explain that one buyer will replace 3 officers with just himself unless we show that 2 of the officers are silent partners NOT working in the business and possibly even show they are employed elsewhere. 3) We will adjust for a buyer specific amount which will cover personal living expenses.

Education and Training Item # 13 Education and Training are NOT “typically” considered an add back and here’s why: 1) If any training is required at all for staff members then this will never be considered. In this case it appears that the software training was done by the seller himself and will have to continue for the buyer or a staff member in the future. 2) If staff training is required and it is out of town then the lender will explore all expenses relating to travel and lodging while understanding the training expense. 3) Exceptions may be that the buyer has all training required to operate this business and it is possible to consider this expense an add back BUT may not be worth the documentation required.

Personal Home Utilities Item # 14 Home Utilities are “typically” considered an add back and here’s why: 1) If and only if the seller is also writing off a home office that the lender deems unnecessary to operate this business. 2) If the entire business is being operated out of his home and he is trying to add back the utilities and office rent then we must explore the new expense and location of the buyer. 3) If the seller is only adding his personal bill into the business expenses then this will be a difficult item to prove.

Owner’s Personal Auto Item # 15 Owner’s Personal Auto are “typically” considered an add back and here’s why: 1) When considering this add back an underwriter looks at whether this vehicle is used for the business and by the business to produce the gross revenues as reported. If this vehicle is not critical to sales then it is usually considered an add back. 2) What is NO LONGER accepted as an add back by lenders as of 2012 are costs related to vehicles. Meaning: Fuel and repairs are NO longer accepted as add backs as proving them is very difficult. 3) We can ONLY add back actual “Lease or loan payments” on that vehicle providing we have proof that the payments were being paid from the business accounts.

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