In a Quality of Earnings (QoE) review, owner-related costs are one of the biggest adjustments. Small business owners often reduce reported profits for tax reasons. They do this by running personal or non-essential expenses through the company. These costs distort performance. Buyers must identify them and adjust to arrive at sustainable earnings / Adjusted EBITDA.
Normalization of Earnings — Earnings reported in the raw income statements are distorted by the owner-related costs, as they are not related to operations. Buyers need to “add back” these expenses to calculate the true performance of the business.
Valuation Accuracy — Buyers and lenders apply valuation multiples to Adjusted EBITDA, not Net Income. If normalizations are missed, buyers risk walking away from a strong deal.
SBA Requirements — Under the SBA 7(a) program, lenders review normalized financials to judge repayment ability. If add-backs are unclear or undocumented, lenders may doubt cash flow. That can slow or even block approval.
Salary and bonuses — Owners rarely pay themselves at true market rates. Some take low pay to save on taxes; others pay themselves far more than a replacement manager would cost. Buyers must reset pay to the fair cost of hiring a general manager or CEO. This adjustment ensures results reflect the business, not the owner’s choices.
Family members on payroll — Spouse, children, or relatives may be listed as employees but may not be actively involved in the business. Buyers should confirm their level of involvement and adjust costs to reflect what it would take to hire a real replacement.
Owners often load extra benefits onto the business. Common examples include:
Health insurance that covers the entire family.
Retirement contributions (401k, SEP IRA, etc.) that are maxed out for tax reasons.
Life insurance where the owner or family is the beneficiary.
Non-business travel — Family vacations often show up as “business trips.”
Meals and entertainment — Dinners, weddings, or birthdays passed off as company functions.
Dues and subscriptions — Golf clubs, gyms, and country clubs used for personal benefit.
Automobiles — Company-paid vehicle leases, insurance, or fuel for the owner’s personal cars.
Home office and utilities — Internet, phone, and household utilities billed to the business.
Recreational assets — Boats or RVs are sometimes categorized as “marketing.”
Rental property — Many sellers own the building where the business operates. Rent is generally not at market levels. Buyers must negotiate a fair lease (or buy the property) and adjust EBITDA.
Key diligence point — Lenders look at future rent obligations, not past owner-friendly terms.
Legal or accounting fees tied to the owner’s personal matters or other businesses.
Estate planning or family trusts charged to the company.
Discretionary donations — Charitable contributions made at the owner’s choice should be added back.
Exception — If donations are tied to brand or community standing, it may continue post-sale and should not be added back.
Owner add-backs are normal, but buyers should approach them with care. Watch for:
Overstated add-backs — Some sellers call regular business costs “discretionary.” Always request supporting invoices and relevant documentation.
Unrealistic rent — Reset rent on seller-owned property to market levels. Understated rent can inflate profits.
Ignored replacement costs — Owners and family often pay themselves below market. Adjust to true replacement costs, or you’ll understate expenses.
Lack of transparency — Add-backs can spark disputes. Require written support and treat weak claims with caution.
Navigating Family-Owned Business Acquisitions — Explore the emotional and structural challenges in buying legacy family businesses, including seller hesitation, valuation gaps, cultural resistance, and last-minute surprises.
Identifying and adjusting owner-related costs is a critical step in small business due diligence. By normalizing these expenses, buyers gain a clearer view of the company’s true earning power. This not only ensures more accurate valuations but also strengthens financing opportunities and reduces the risk of costly surprises after closing.
Ready to move forward with confidence in your acquisition? Partner with O’Connell Advisory Group to uncover the real earning power of your target business.