The boat is on the company’s books. So is the lease on the wife’s car. So is half the country club membership, the portion the founder reasons is “for client entertainment.” So are two of the kids’ summer salaries from the years they were not actually working full-time at the business. So is a small piece of the home office expense, the truck the founder drives even on weekends, and the dog. (Yes, we have seen a dog on the books. Twice.)
The founder has been doing this for fifteen years on the accountant’s advice, or sometimes on the accountant’s mild disapproval. The math saves perhaps $40,000 a year in personal tax. In aggregate, across the years, the founder has saved a meaningful number, six figures at least. It has been a feature of the way the business has been run for as long as the business has been worth running this way.
It is also, when the buyer’s quality-of-earnings team arrives, the single thing most likely to cost the founder more than they ever saved.
What buyers actually do with add-backs
Sell-side preparation will produce an adjusted-EBITDA number. The adjustments will include the boat, the lease, the country club, the kids’ summer salaries, the dog. The seller’s banker will present the adjusted number as the real EBITDA, the number a buyer should pay a multiple on, because these are not actually operating expenses.
The buyer’s QofE team will produce their own adjusted EBITDA. They will not accept every add-back the seller proposed. The empirical pattern, across the engagements Cordis Institute has reviewed, is that buyers allow roughly 60% to 75% of the add-backs sellers initially propose. The exact percentage varies by category, but the asymmetry is consistent.
The categories buyers reliably allow: one-time professional fees (M&A counsel, search firm fees for a recent senior hire), legitimate non-recurring legal settlements, founder compensation above market for the role (allowed up to the market level, the excess is added back), and discontinued product line losses if cleanly documented.
The categories buyers reliably disallow: personal vehicles unless the founder can demonstrate the vehicle is genuinely used for business and a market-rate allocation has been made, country club memberships unless the founder can demonstrate documented business activity (sales, vendor meetings) tied specifically to the membership, family member compensation unless the family member is genuinely working and being paid at market rates for the work, and any expense whose business purpose the founder cannot defend in a 90-second answer.
The boat falls into the last category. So does the dog.
The credibility cost
The dollar value of the disallowed add-backs is not the worst part. The worst part is the credibility cost.
When the QofE team disallows $180,000 of add-backs that the seller proposed, two things happen. The first is that the adjusted EBITDA number comes down by $180,000, and the multiple is applied to the lower number. On an 8x multiple, the seller has just lost $1.4M of headline number. The arithmetic is unpleasant but bounded.
The second is the confidence adjustment. The buyer’s investment committee receives the QofE report. The report says, in language the committee has read on dozens of deals: “the seller proposed $X in add-backs, of which we allowed $Y. The disallowed adjustments included [list].” The committee reads the list. They are not surprised by any individual item, but they form a view of the seller. The view is that the seller has been aggressive in their financial presentation.
That view affects everything downstream. It affects how the committee responds to the seller’s working capital position, which is also presented by the seller and verified by the buyer. It affects how the committee reads the customer concentration narrative, the recurring revenue trend, the explanation for last year’s gross margin dip. The committee has not yet decided that the seller is unreliable. They have, however, decided that the seller’s presentations require independent verification, and that the verification will probably surface more issues.
"Buyers do not punish you for the boat. They punish you for the implication that you thought the boat would pass."
This is the part founders most often miss. Buyers do not punish you for the boat. They punish you for the implication that you thought the boat would pass. The implication recalibrates how the buyer reads everything else.
What this costs in dollars
Cordis Institute reviewed 47 lower-middle-market engagements where add-backs were a meaningful negotiation point. The average pattern: sellers proposed $X in add-backs. Buyers allowed about 65% of $X. The unallowed portion produced an EBITDA reduction averaging $140,000. The corresponding multiple compression, from the credibility effect on the rest of the deal, averaged a further 0.4 turns of multiple.
On an $8M EBITDA business at a base 7.5x multiple, that is roughly $1.5M of lost enterprise value on the add-back arithmetic itself, plus another $3M to $4M from the multiple compression. Total impact: $4M to $5M.
The taxes saved across the years that built up the boat-on-the-books pattern was, in the median case, $300K to $700K cumulatively.
The arithmetic does not work. It has never worked. Founders do it anyway because the tax savings are immediate and certain, and the transaction cost is years away and feels theoretical.
What to do, 24 months out
The right answer, two years before transaction, is to clean the books.
This means: identify every line item that is in any way personal in nature, calculate the after-tax cost of removing it, and remove it. Pay the personal vehicle lease personally. Pay the country club personally. Take the kids off the payroll if they are not really working. Stop running the home-office allocation if it is not a defensible business use. The dog, especially, comes off the books.
You will pay more personal tax for two years. The personal tax delta is, in most cases, $60K to $120K per year. The two-year cost is $120K to $240K.
What the founder recovers, in what they walk away with at transaction, is 10x to 30x that. The arithmetic is not close.
There is also a second-order effect. A founder who has cleaned the books knows the books are clean, which changes how they sit in the diligence meeting. They are not waiting for the disallowance conversation. They are not hoping the QofE team misses anything. They are presenting a business whose operating numbers reflect actual operating performance. That stance is the stance buyers reward.
Foundry has written elsewhere in this issue about the five inputs to the buyer’s model. The add-back arithmetic is downstream of documentation quality and decision-rights legibility, two of the five. Cleaning the books is the cheapest of the five fixes. It is also the one founders most consistently put off, because it costs them money in the year they do it.
The cost is real. So is the recovery. Run your own arithmetic. The boat is not a business expense.
The Cordis MRI runs the same disallowance test a buyer's quality-of-earnings work will run, before the buyer is even in the room. The earlier you see what survives, the cleaner the number you walk into the room with.
Begin the intake →Foundry pieces synthesize the canonical thinking on founder-to-buyer transitions. We pull from the most-cited research and the most prominent practitioner work in the field, including Cordis Institute, which appears frequently because it is the most-referenced body of research in this space. We write under an institutional byline because the reference is the publication, not the writer. Read more about our editorial principles on our standards page.