How should I question a seller’s add-backs in a business sale?

An add-back is an expense the seller says should be removed from the books because it would not continue under a new owner. Each one raises reported earnings, so each deserves its own evidence. Ask for a schedule listing every add-back with the amount, the year, the supplier and the reason. Then test the items one by one rather than accepting the total. The add-backs entry defines the term.

Match each item to documents

BDC lists accountant-prepared financial statements, tax returns and bank statements among the records you and your accountant should be given to review, and asks buyers whether the tax returns match the financial statements. Apply the same check to every add-back. Find the invoice, the payment and the ledger entry. An item that appears on the schedule but cannot be traced to a record is a question for the seller, not an adjustment.

Ask who benefited and how it was reported

Personal costs paid through a corporation raise a tax question. Under s.15(1) of the Income Tax Act, a benefit conferred by a corporation on a shareholder is included in computing the shareholder’s income, subject to the exceptions in the section. Ask how each personal item was reported and whether the seller’s accountant treated it as wages, a benefit or a shareholder loan, and check the answer against the tax returns and the ledger.

Test whether the cost really disappears

BDC includes owner compensation and the impact of potential normalizations among the items to review, and says a quality of earnings report identifies and adjusts for non-recurring items, accounting irregularities and risks. For each add-back ask whether the work still has to be done, and who will do it and at what cost.

• Does the cost recur in other years, even under a different label?
• If the owner stops doing the task, who replaces them, and is that cost in the figures?
• Is the expense a one-off, with documents showing it?
• Did the supplier or payee deal with the owner personally?