Capittal's view: do my personal expenses in the company cut the price?

Quick answer

Capittal's view is that your personal expenses inside the company do not cut the price by themselves: what cuts the price is being unable to document them. A private cost that is identified, quantified and evidenced is added back to EBITDA as a normalisation adjustment and raises the price. A cost you cannot explain stays inside EBITDA and is multiplied by the multiple against you.

What is normalised EBITDA and why does the buyer buy that number instead of my accounts?

The buyer does not value the profit shown in your statutory accounts. They value the recurring profit the business would generate in a third party's hands, without you inside it and without your personal decisions. That figure is normalised EBITDA, also called adjusted EBITDA.

The calculation takes one line to explain and a hundred to defend. You start from accounting EBITDA, add back the costs that will not continue after the sale and deduct the income or savings that will not continue either. The multiple is applied to that result, and the price comes out of it.

That is why no euro argued over in an adjustment is worth one euro. It is worth one euro times the multiple. At a multiple of six times, an accepted adjustment of 40,000 euros a year is 240,000 euros of price; the same adjustment rejected is 240,000 euros left on the table.

Which of my expenses are usually accepted as an adjustment?

What gets accepted is identifiable, quantifiable and unrelated to the recurring business. These are the adjustments a mid-market buyer accepts without a long argument when they arrive documented.

• Owner pay away from market. What you draw is replaced by what it would cost to hire a managing director for your job.
• Cars used privately. Lease, fuel, insurance and maintenance for the car the family uses rather than the business.
• Costs of family members with no real role. Payroll, social security contributions and allowances for people who do no effective work in the company.
• Off-market rent on a property owned by the shareholder. The gap between the rent charged and market rent is adjusted.
• Non-recurring costs. A lawsuit and its legal fees, a move to a new site, an exceptional severance payment, a one-off consultancy project.
• Ordinary personal spending. Mobile phone, trips with no business element, private meals, club fees, family health insurance.

The pay adjustment works in both directions. If you pay yourself well above market, it lifts EBITDA. If you pay yourself 30,000 euros to run a business that would need a 90,000-euro managing director, it reduces EBITDA. A serious buyer does that subtraction as readily as the addition.

Which expenses will not be accepted, and why?

The buyer's filter is not moral, it is evidential. These adjustments almost always fall away.

• The cost with no support. Cash payments, invoices with no description, charges nobody can tie to a person or a specific use.
• The cost the business needs. Client entertainment that sustains sales is not an owner's extra: remove it and revenue falls.
• The recurring cost dressed up as exceptional. The lawsuit that appears every year and the repair that recurs every two are ordinary operating cost.
• The round-number adjustment. Saying there is roughly 100,000 euros of my own spending, with no breakdown by account, amount and year, is an estimate, not an adjustment.
• The future saving. Synergies, rents you intend to renegotiate or contracts you have not signed yet do not belong in the historical numbers.
• The cost you cannot acknowledge in writing. If documenting the adjustment means admitting a tax irregularity, the adjustment will never reach the table but the problem will.

How do I document each adjustment so it survives due diligence?

Every line of the adjustment needs three things: exact accounting identification, the amount per financial year, and external evidence. Without all three, it is an opinion.

• Traceability. Ledger account, journal entry, invoice and date. An adjustment that cannot be traced back to the general ledger does not exist for the buyer's adviser.
• A three-year series. The same criterion applied to all three years the buyer will review, not only to the last one.
• Market evidence. For pay, a role benchmark or a genuine offer. For the shareholder's rent, a valuation or comparables from the same area.
• Evidence of non-recurrence. A judgment, a settlement agreement, a one-off invoice, a closed contract. Something that shows the cost does not come back.
• One single schedule. One bridge from accounting to normalised EBITDA, one line per adjustment with the support linked. You, your adviser and your auditor must quote the same figure.

What happens in due diligence when an adjustment does not hold up?

Financial due diligence does not argue with your intentions. It checks the support. When the support is missing, this happens, and in this order.

• The adjustment falls. Normalised EBITDA drops by the full amount of the adjustment, in every year affected.
• It is multiplied. The fall in EBITDA passes into the price multiplied by the agreed multiple.
• It spreads. One adjustment falling makes the buyer scrutinise the rest and apply a prudence discount across the whole set.
• It hits the earn-out. If deferred consideration is calculated on EBITDA, a lower starting EBITDA with the target left untouched makes your earn-out unreachable.
• The structure changes. Less cash at closing, more deferred price, a larger holdback and more conditions.

Can I be pursued for tax or employment liabilities for running private costs through the company?

Yes, and the buyer thinks about it before you mention it. These are the real exposures in Spain.

• Corporate income tax. Article 15 of Spain's Law 27/2014 denies deduction for gifts and gratuitous payments and caps client entertainment at 1% of net turnover. A private cost deducted means unpaid tax, late-payment interest and a possible penalty.
• Personal income tax and social security. Private use of a company car or company home is a benefit in kind: it must be valued, subject to a payment on account and included in social security contributions. Where the company provides the car, Spanish rules value the use at 20% of the acquisition cost per year.
• Related-party transactions. Article 18 of Law 27/2014 requires the rent your company pays you to be set at market value, documented, and reported on Spain's form 232 once the thresholds are exceeded.
• An open window. The Spanish tax assessment period is four years from the end of the filing deadline, under article 66 of Spain's General Tax Act. The buyer inherits that open window with you inside it.

That is why it is treated as a contingency and not as an anecdote. It is covered with tax representations and warranties in the sale agreement, a specific indemnity for that risk, an amount held in escrow until the period expires and, if the figure is material, a straight reduction in price.

The advice here admits no nuance: regularise and document, never conceal. Concealing it does not remove the risk, it moves the risk into the representations you will personally sign and leaves it attached to your own assets for years after the sale.

What should I do in the twelve months before the sale?

Twelve months is enough to present one clean financial year and a credible bridge. This is the order that works.

• Inventory. List every personal cost running through the company, with the account, the annual amount and who benefits. No exceptions and no rounding.
• Separation. Take out of the company what is yours: the car moves into your name, the club fee to your own account, and the family member with no real role either leaves the payroll or acquires a real role, contract and working hours.
• Regularisation. With your tax adviser, assess amended returns and the correction of years still open to assessment. Doing it before the sale is cheaper than negotiating it with a buyer across the table.
• Related parties at market. A written lease with the shareholder, rent supported by a valuation or comparables, and your own pay set out in a contract with defined duties.
• A clean track record. Close at least one financial year with the books already tidy. One clean, reviewed year negotiates better than five years of explanations.
• A live bridge. Keep the normalisation schedule updated month by month, with the supporting document attached to every line.

What is the next step if I have personal expenses in the company?

Take the profit and loss account for the last three financial years and mark, line by line, which cost would disappear if the company belonged to somebody else tomorrow. Write next to each line the amount per year and the document that proves it. What is left without a document is your work list; multiplied by your multiple, it is the price you will leave on the table.

At Capittal Transacciones we build the bridge to normalised EBITDA and its supporting evidence as part of the confidential valuation we prepare for owners considering a sale. We are a mid-market M&A boutique operating in the approximate range of 3 to 250 million euros, with eight offices in Spain (Barcelona as headquarters, Madrid, Girona, Lleida, Tarragona, Palma, Zaragoza and Valencia) and we are part of the NRRO group. The partner handles each mandate directly, including the conversation about which of your expenses will be accepted and how they are proven.

Keep reading

• Guide: every decision you face when selling your company
• From headline price to bank account: what you actually take home
• Mistakes that reduce the price when selling

Build a defensible EBITDA before going to market: talk to Capittal