Guide
4 min read
By MSP Margin Editorial
Most MSP sale discussions eventually center on EBITDA: earnings before interest, taxes, depreciation and amortization. The figure on your tax return or year-end income statement is rarely the one that gets discussed, though. Sellers propose adjustments, often called add-backs, to show what the business would earn under a new owner. Buyers then test those adjustments, often through a formal quality-of-earnings review performed by an outside accounting firm.
The process is legitimate. Owner-run businesses carry costs that will not continue after a sale, and it is fair to remove them. The trouble starts when the adjustments drift from normalizing the business into describing a business that does not exist.
Add-backs buyers generally accept
The most common adjustment is owner compensation. If the owner pays themselves more than it would cost to hire someone to do the same job, the difference can be added back. The reverse also applies: if the owner takes a small salary and works sixty hours a week, a buyer will reduce EBITDA to reflect the cost of replacing that work at market pay.
One-time costs are the second category. An office relocation, a lawsuit settlement, a PSA migration or a one-off consulting project may reasonably be removed if they are truly nonrecurring. The test is whether something similar shows up most years. An MSP that has a "one-time" tool migration every year has a recurring cost.
Personal expenses run through the business are the third. Family vehicles, personal travel, a family member on payroll who does not work in the business, and similar items can be added back when they are documented and clearly unrelated to operations.
Where buyers push back
Weak add-backs tend to fall into a few patterns. The first is the unsupported market rate. A seller adds back most of their salary on the claim that a manager could be hired cheaply, but the role they actually perform would cost far more to replace. Reviewers look at what the owner does day to day and price that.
The second is the vacancy add-back. A technician quits, the seller does not replace them, and the saved salary gets added back on the theory that the business runs fine without the role. If the remaining team is working overtime, response times are slipping, or the owner is filling the gap, the buyer will see a cost that has been deferred, not eliminated.
The third is the pro forma add-back: savings or revenue that have not happened yet, such as a planned price increase or a vendor switch. Buyers may discuss these as upside, but they rarely accept them as part of current earnings.
Documentation matters for all of them. An add-back with invoices, payroll records and a clear explanation behind it is far easier to defend than a single line on a summary schedule.
An illustrative example
Consider a hypothetical MSP with reported EBITDA of $400,000. The owner proposes four adjustments:
- Owner salary of $250,000 against an estimated market cost of $150,000 for a general manager: add back $100,000
- An office move: add back $30,000
- Personal vehicle and family phone plan paid by the company: add back $15,000
- A technician who left and will not be replaced: add back $80,000
That brings the seller's adjusted EBITDA to $625,000.
In the quality-of-earnings review, the reviewer accepts the office move and the personal expenses as documented. After looking at the owner's actual responsibilities, which include running the service desk and handling escalations, the reviewer prices the replacement role at $180,000, so the owner compensation add-back drops to $70,000. The technician add-back is rejected because the remaining team is absorbing the work with overtime.
The reviewed figure is $400,000 plus $70,000, $30,000 and $15,000, or $515,000. That is $110,000 less than the seller's number. The gap came from two adjustments, and both could have been anticipated before the review started.
Building a defensible schedule
Prepare your add-back schedule the way a reviewer would. Tie every adjustment to the general ledger and supporting documents. Use a realistic replacement cost for your own role, based on what you actually do. Leave out vacancies and future savings, or present them separately as potential upside. A smaller adjusted number that holds up through diligence does more for a seller than a larger one that gets cut apart.
This article is general information, not legal, tax or transaction advice. Sellers should work with their CPA, an M&A advisor and an attorney when preparing EBITDA adjustments and negotiating a sale.