Every seller wants to present the highest defensible EBITDA. That's not a character flaw; it's rational behavior. The question for a buyer is whether the adjustments being claimed actually hold up when someone looks at them carefully.
Most problematic addbacks don't involve outright fabrication. They involve generous interpretation: classifying recurring costs as one-time, normalizing compensation in ways that don't reflect market reality, or presenting the business at its best year while hoping you don't dig into the others. A thorough Quality of Earnings analysis is designed to catch these. Understanding what to look for before you commission one makes you a sharper buyer throughout the process.
No. 1 — The "One-Time" Expense That Isn't
This is the most common problematic addback in lower middle market deals. The seller identifies an expense in the current year as non-recurring and adds it back to EBITDA. Legal fees, consulting costs, a bad debt writeoff, a technology implementation — the specific category varies, but the pattern is consistent.
The problem surfaces when you pull prior year financials and find the same category of expense appearing in year two, year three, or both. Businesses face legal disputes periodically. They hire outside consultants regularly. They write off bad receivables as a matter of course. If an expense type has appeared more than once in the trailing three years, the burden of proof for calling it non-recurring is high.
What to ask: Request three years of detailed general ledger data, not just summary financials. Look at the account in question across all periods. If the expense recurs in any form, it belongs in the run-rate cost base, at least partially.
No. 2 — Owner Compensation Normalized Too Aggressively
Owner compensation addbacks are legitimate when done correctly. The seller adds back their above-market salary, and the buyer underwrites the business assuming a market-rate replacement will run it. The problem is how sellers define "market rate."
A seller paying themselves $500,000 in a business that a competent general manager could run for $150,000 has a defensible $350,000 addback. A seller paying themselves $500,000 and claiming a $400,000 addback because "a replacement CEO for a business this size would cost $100,000" is making an assumption that deserves scrutiny.
Owner compensation addbacks often appear alongside personal expense addbacks, family member salary addbacks, and owner's vehicle addbacks — all in the same package. Each one may be individually defensible. Taken together, they can represent 40–60% of adjusted EBITDA, which warrants extra scrutiny of the aggregate picture, not just each line item.
What to ask: Request comparable compensation data for the role being normalized. A $50,000 error in the replacement cost assumption becomes a $200,000–$300,000 error in purchase price at typical multiples.
No. 3 — Revenue Pulled Forward to Inflate the TTM
Sellers know that buyers care most about recent performance. The trailing twelve months (TTM) is the primary earnings period most buyers underwrite to, which creates an incentive to make that period look as strong as possible.
One way this happens is through revenue timing. A seller might accelerate the recognition of a large contract, invoice a customer early for work not yet completed, or push a renewal forward by offering a discount. The revenue is real, in the sense that the customer relationship exists, but it has been shifted in time in a way that flatters the TTM and borrows from the next period.
What to ask: Request a month-by-month revenue breakdown for the trailing 24 months and compare the cadence. Significant spikes in the most recent quarters warrant explanation. Also request copies of the top five customer contracts and renewal terms.
No. 4 — Below-Market Rent from an Owner-Controlled Property
Many small business owners also own the real estate their business operates from and charge the business rent. When that rent is set below market, the business's reported expenses are artificially low, and its EBITDA is artificially high.
From the seller's perspective, the below-market rent is a feature: it makes the business look more profitable. From the buyer's perspective, it's a liability: after closing, you'll either need to negotiate a new lease at market rates or factor the difference into your return analysis.
What to ask: Request a copy of the lease agreement and the terms of any related-party arrangement. Then pull two or three market rent comparables for similar space in the same submarket. The difference between the lease rate and the market rate, annualized, is a cost the reported EBITDA is currently hiding.
No. 5 — Capitalizing Expenses That Should Be Expensed
When a business capitalizes a cost (puts it on the balance sheet as an asset rather than running it through the income statement as an expense), it reduces the expense burden in the current period and improves reported EBITDA. The cost still exists; it just gets spread across future periods through depreciation.
In lower middle market businesses, this most commonly appears with software development costs, website builds, equipment purchases that blur the line between maintenance and improvement, and marketing campaigns that the seller argues have long-term value. When the pace of capitalization accelerates in the year or two before a sale, it's worth asking whether the timing is coincidental.
What to ask: Compare the ratio of capitalized costs to total investment spending over the trailing three years. If that ratio has increased recently, ask the seller to walk through each capitalized item and their rationale for the treatment.
These Often Appear in Combination
The most aggressive deal packages don't rely on a single large questionable addback. They layer several smaller ones, each defensible on its own, that collectively shift adjusted EBITDA well above what the business actually generates on a sustainable basis. If you find one of these issues, look for the others. They tend to travel together.
QoEPro provides buy-side Quality of Earnings reports for independent sponsors, search fund entrepreneurs, and private equity buyers in the lower middle market. Our reports are built to catch exactly these kinds of adjustments before they become post-close surprises. View report options →