Add backs to calculate SDE - apply a haircut?

March 19, 2020

by a searcher in Los Angeles, CA, USA

I am reviewing a P&L where the owner has considerable add-backs to calculate his SDE. Is there a general rule to apply a haircut to these personal expenses (especially when considering an SBA loan)? For due diligence (if it gets to that), I will probably ask for detailed records to prove these are truly personal expenses....any other thoughts/tips/suggestions?

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Reply by a professional
from Villanova University in New York, NY, USA

I agree with Brandon and Jason. I would add that you'll want to see the general ledger as well to make sure the expenses are recorded on the P&L in the proper periods. You would want to review the cancelled checks, bills/invoices etc, and vouch them to the bank statements and the general ledger. Sometimes a Seller will try to add back "expenses" that were not recorded to expense, but rather, were recorded to owner's draw, which is an equity account. If recorded to draw, there would be no P&L impact and therefore no addback.

Also, a Seller might pay their credit cards every other month. In this case, the cash payment that hit the P&L is not in the period in which the expense was incurred ("last month"). So be careful of timing too. It could easily impact your ultimate addback amount. I would be happy to discuss further if you'd like.

Reply by a lender
from Michigan State University in Newport Beach, CA, USA

Hey Sarim. You want to get all of the invoices/cancelled checks, simply for your due diligence. From an SBA standpoint, most lenders will consider major line items....officer comp, int, depr/amor, and perhaps auto payments and healthcare costs. What lenders usually do not consider is meals, travel, entertainment, cell phone, and credit cards. The appraiser may use those addbacks for valuation, but underwriters will likely not use them for loan sizing. Thus, you still want all of the evidence so you know exactly what you're buying. You also want to look at the tax returns, as that's what banks will use for historicals. P&L is only good for the current year.

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