Amortization as an Add-Back?

June 01, 2023

by a searcher from University of Virginia-Darden - Darden School of Business in Richmond, VA, USA

In our world, so much depends on valuing a company well. And usually I look at some combination of discounted cash flows and EBITDA. I've bought a couple companies now but there's still something I don't understand. When you see "amortization" in the add-backs is that amortization of some asset the business has or some loan? I have seen sellers and brokers try to add-back both but the amortization dollars to pay off a loan are already captured in the starting point of net income. So that makes no sense to me and it appears they're double counting it toward EBITDA. If it's the former, that makes some sense I guess. The reason I asked this is that I recently saw a CIM with huge add-backs and thought I'd bring the point up before a bunch of smart minds.

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Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

The confusion is that the word "amortization" has two meanings. ^redacted‌ has explained well.
The intangible asset amortization (X) reduces the intangible asset value on left side of the balance sheet, X is a non-cash expense in P&L and hence IS an add-back.
The loam amortization (Y) is a debt principal repayment. It reduces the outstanding loan on the right side of the balance sheet. Y is not an expense item; on the P&L and is NOT an add-back. (Edit: Adding this after reading ^redacted‌ comment: To the extent, Y has been deducted as an expense in P&L, knowing or unknowingly, Y should be added back in calculating adjusted EBITDA because, had Y not been expensed, the reported profit would been higher.)
I have seen 1000+ CIMs prepared by other brokers. I have also done add-backs for 1000+ sellers. I have not run into a broker and/or seller adding both X and Y,
See example below:
I once represented a glass trophy blank mfg. business. Seller bought equipment and grinding wheels (and other supply items) from the same distributor. Business was growing. One additional equipment was purchased on a capital lease, but it was not put on the balance sheet (an unintentional error). Seller paid one combined monthly payment to the distributor for supplies and loan repayment. Accountant thought all payments were for consumable supplies and expensed all. This kind of unintentional error does occur in SMB where many sellers do not have finance background.).

Reply by a professional
from The College of New Jersey in La Verne, CA 91750, USA

Intangible asset amortization from a tax perspective occurs when an acquisition is structured as an asset sale or an election has been made to treat an equity acquisition as a taxable transaction. There are other nuances when dealing with LLC targets (usually the buyer will recognized stepped up basis in the assets, while any rollover equity holders will maintain their existing tax basis). There is a tax consequence to the seller in the form of recognizing a greater gain on the sale and tax benefit for the buyer (tax amortization on the assets acquired). In having seen hundreds of transactions in the middle market, I can say that transaction pricing most certainly is impacted by a transaction's tax structure. Whether that's an explicit calculation in a deal model or an adjustment made during negotiations, it does usually come into play on determining purchase price.

Amortization as others have said is a noncash expense, so would be added back to calculate a business' EBITDA. CIMs and QoEs in my experience typically consider book income (closer to GAAP basis) whenever possible, which is different than tax income. Buyers and sellers should have someone knowledgeable about the tax issues in an M&A context on their team to identify these types of issues, particularly for targets with significant fixed and intangible assets. The tax man gets what he is due always and that is a real cash outflow as we all know.

Hope this helps.

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