Unlocking Value: A Deep Dive into EBITDA Add-Backs

We previously discussed EBITDA/cash flow as the primary metric utilized in valuing HOA and condo management companies. In this post we'll delve more deeply into EBITDA add-backs (and burdens).

EBITDA Add-Backs

To the extent a business incurs non-recurring or abnormal expenses, sophisticated investors will typically back out those expenses from the P&L and treat them as EBITDA "add backs." This process of identifying and validating such add-backs becomes something of a negotiation in a sale process. Let's do an example. Company C is an HOA business and its last twelve month P&L appears as:

When Company C's CEO/Owner works with its selling broker, the broker discovers the following expenses included in the "Other" category in costs:

After the close of a potential transaction, the CEO/Owner will not run the business and as such the new owners will likely not expense any Concert Tickets, Company Car or Political Donations. As a result, the broker will make the case that the Company's EBITDA should be presented as higher than the original $73k:

However, as mentioned, the add-backs can also be subject to negotiation. Let's say the Concert Tickets were used as a tool to win new clients. The potential buyer(s) may include that $20k cost as part of a standard sales and marketing budget and choose not to elect it as an add-back. For now, however, we will keep the add-backs in.

EBITDA Burdens

Upon further investigating the Executives Payroll of $290k, the selling broker discovers that the CEO/Owner pays his/her top two lieutenants a total of $250k, and the CEO/Owner only takes a salary of $40k (but as the Owner, can pull out any cash generated by the business). If the top two lieutenants' jobs do not include CEO responsibilities, the broker may need to further burden the EBITDA figure for a market-rate CEO salary. Let's say that figure is $150k in the specific market and size bracket in which the CEO/Owner's business operates:

The Adjusted EBITDA of the business declines by the difference between the market rate and current compensation of the CEO/Owner. Note that the opposite can also be true: if the CEO/Owner had been compensating his/her herself at an above-market rate, the adjustment would be an add-back, not a burden.

The tabulation of the add-backs in a given transaction are often completed by the CEO/Owner and selling broker working in tandem, but can also be completed as part of a quality of earnings (QoE) process conducted by a third party. QoE process expenses can be borne by either the buyer or seller, depending on the process.

Conclusion

EBITDA add-backs and burdens are used in valuing nearly every HOA and condo management deal. Sellers should adjust for non-recurring or owner-specific expenses. These adjustments often involve negotiation, as buyers and sellers assess whether costs should be included or excluded from EBITDA calculations.

For more information on the HOA management industry, valuation metrics, or other questions, please contact contact@camadvisors.co or visit camadvisors.co.