Addbacks are adjustments to reported earnings that remove non-recurring, unusual, or owner-specific expenses to reveal the true ongoing earning power of a business. The adjusted EBITDA (EBITDA plus addbacks) is then multiplied by the agreed multiple to determine the purchase price, making addback negotiation a direct lever on deal value. For example, if an owner pays themselves $400,000 but the position warrants $100,000, the $300,000 difference gets added back to increase the business valuation by that amount times the purchase multiple.

Universal addbacks appear on almost every small business deal and include food, travel, salary paid to family members who don't work there, gas, automobile expenses, personal insurance, entertainment, home office costs, personal phone bills, country club memberships, and personal subscriptions. These baseline personal expenses inflate operating costs and depress stated Seller Discretionary Earnings (SDE). The total of universal add-backs on a typical small business ranges from $30K-$150K depending on business size and owner spending habits.

Owner compensation above market rates represents the most common adjustment category. If the owner-CEO receives $500,000 annually but comparable executives earn $200,000, the $300,000 excess normalizes EBITDA upward. The principle is straightforward: small business owners often inflate their compensation for tax purposes, but buyers need to understand the true cost of replacing that function. This addback directly increases the business's apparent profitability and purchase price.

Transaction-related expenses including investment banker fees, legal costs, and Quality of Earnings fees themselves are one-time costs that get added back to EBITDA. These expenses occur exclusively during sale processes and never recur under normal operations, making them categorically non-operational. Since buyer operations will not replicate seller transaction costs, they receive automatic add-back treatment and shouldn't be factored into the ongoing earning power of the business.

Non-recurring operational expenses possess identifiable triggers, lack predictable repetition, and carry explanatory narratives distinguishing them from operational inefficiency. Discontinued product line losses, facility closure costs, and restructuring charges qualify when the buyer will not repeat these activities. Inventory write-offs qualify selectively based on underlying cause - temperature-sensitive goods lost due to refrigeration failure represent non-recurring loss, while obsolete inventory from poor purchasing decisions may not qualify.

Litigation settlements and insurance recoveries outside ordinary operations normalize earnings and typically qualify for addback treatment. One-time charitable donations run through the business also qualify - a $50,000 donation that was a personal decision rather than a business necessity gets added back. The key criterion is whether the expense or recovery represents ongoing business operations or a one-time event that won't continue under new ownership.

The foundation question is: "What personal expenses are you running through the business?" However, sellers will understate this. Frame disclosure as value-increasing rather than accusatory: "Everyone does it. We need to know so we can add it back and increase your valuation." This normalizes the behavior and gets more honest answers. Follow up with specific categories like automobile costs, club memberships, family member salaries, and occasionally unusual items like a partner's rent payment.

Quality of Earnings (QoE) analysis is closer to a formal audit, typically involving an independent third party who examines each month separately for trailing 36 months (three fiscal years), used for larger acquisition prices. Seller Discretionary Earnings (SDE) analysis is less formal, examines financials in aggregate rather than month-by-month, and is appropriate for smaller acquisitions. Both methods center on EBITDA with addbacks, but QoE provides higher rigor and detail for deals requiring greater due diligence scrutiny.