SDE Normalization Schedule

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TABLE OF CONTENTS

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• Purpose & Methodology .......................... 1
• Standard Add-Back Schedule .................... 2
• SDE Reconciliation ............................. 3
• What Buyers Will Discount ..................... 4
• Caveats & Pre-Listing Recommendations ......... 5

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#### 1. Purpose & Methodology

This Standard Normalization Schedule isolates and documents the adjustments applied to reported Net Profit in arriving at Seller's Discretionary Earnings (SDE). It is a standalone financial document that buyers, their CPAs, and SBA lenders will pull and review independently of the broader Valuation Report. The Multiple Determination in Deliverable 1 is anchored to the SDE figure produced by this schedule; if a buyer's Quality of Earnings (QofE) review challenges any line item, the multiple defense in Deliverable 1 must absorb that haircut directly. For that reason, every add-back here is constructed to be defensible under standard QofE scrutiny.

SDE differs from Net Income in three material ways. First, SDE captures the full economic value available to a single owner-operator buyer who will replace the seller — meaning W-2 compensation, employer-side payroll tax on that compensation, and benefits paid through the business are added back. Second, SDE adds back personal expenses run through the business that a new owner would not incur or would incur personally. Third, SDE removes non-cash items (depreciation, amortization) and one-time/non-recurring expenses that distort the business's go-forward earnings power.

The distinction between defensible add-backs (documented personal expenses, replaceable owner comp, verifiable one-time items) and aggressive add-backs (projected synergies, hypothetical cost savings, extrapolated growth) is critical. This Schedule includes only defensible add-backs. Aggressive add-backs are explicitly excluded — they will be challenged in QofE review and create asking-price re-trade risk if presented.

The Advanced Normalization Schedule generated in Stage 3 of this Enterprise package will reference the totals here and overlay document-verified granular adjustments where uploaded financial documents support deeper line-item analysis.

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#### 2. Standard Add-Back Schedule

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#### 3. SDE Reconciliation

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Net Profit (2025) $380,000 [VERIFIED]

+ Owner W-2 Compensation $95,000 [VERIFIED]

+ Employer Payroll Tax on Owner W-2 (7.65%) $7,268 [CALCULATED]

+ Owner Health Insurance $22,000 [VERIFIED]

+ Personal Vehicle $14,400 [VERIFIED]

+ Depreciation & Amortization $32,000 [VERIFIED]

+ One-Time / Section 179 Truck $12,600 [VERIFIED]

+ Other Personal Expenses $0 [VERIFIED]

+ Family Payroll Adjustments $0 [VERIFIED]

+ Related-Party Rent $0 [INSUFFICIENT DATA]

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= 2025 RECONCILED SDE $563,268 [CALCULATED]

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Tie to Layer 1: This $563,268 reconciled 2025 SDE figure matches the Layer 1 PRE-CALCULATED 2025 SDE exactly. The Weighted SDE used in the Valuation Report ($500,268 [CALCULATED]) is derived from this 2025 figure plus 2024 ($458,268) and 2023 ($395,268) using the 3/2/1 weighting documented in Deliverable 1.

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#### 4. What Buyers Will Discount

A sophisticated buyer's QofE review treats each add-back with a different level of scrutiny. Below is the line-by-line treatment a buyer's CPA will apply to Desert Sun HVAC's specific adjustments:

Owner Compensation ($95,000 / $0 adjustment). The owner's $95,000 W-2 sits within the BLS replacement-wage band for an HVAC service manager in Nevada. A buyer's CPA will request BLS or industry comp survey data to confirm. No haircut expected; this is one of the cleaner lines in the schedule.

Owner Health Insurance ($22,000). Accepted at full value if premium invoices and W-2 box 12 reporting are available. The full $22,000 represents 4.4% of weighted SDE — a material line, so buyer scrutiny will be proportionate. Recommend pulling the premium statements before listing.

Personal Vehicle ($14,400). This is the single most-discounted line in typical QofE review. Without contemporaneous mileage logs, expect a 30–50% haircut — meaning the buyer may credit only $7,200–$10,080 of the $14,400 [CALCULATED]. At a 3.25x multiple, the asking-price impact of a 50% haircut on this line is approximately $23,400 [CALCULATED]. Recommend the seller construct a defensible business-use percentage with whatever documentation is available before the QofE phase.

Depreciation & Amortization ($32,000). The add-back itself is mechanical and uncontested. Buyers will, however, separately assess maintenance CapEx — the annual capital spend required to keep the fleet and equipment operating at current capacity. If maintenance CapEx exceeds reported D&A, the buyer's effective SDE is lower than the headline figure. This is not a haircut to this line but a separate negative adjustment buyers calculate alongside it. Equipment-fleet condition was not captured at intake — this is a meaningful gap.

One-Time / Section 179 Truck ($12,600). This line is the most likely to be partially challenged. The Section 179 deduction is real and was concentrated in one year, but trucks are replaced on a recurring cycle in HVAC operations. A skeptical buyer's CPA may credit 50–75% of this add-back (i.e., $6,300–$9,450) and treat the balance as a recurring fleet-replacement reserve. At a 3.25x multiple, a 50% haircut on this line is approximately $20,475 in asking-price impact [CALCULATED].

Cumulative QofE Haircut Range. Stacking moderate haircuts across the personal-vehicle and one-time-truck lines (the two most-scrutinized items), expect a $7,200–$13,500 reduction in adjusted SDE [CALCULATED — from haircuts of ~50% on personal vehicle ($7,200) plus ~50% on Section 179 ($6,300)]. At the Base Case 3.25x multiple, this translates to $23,400–$43,875 in asking-price exposure [CALCULATED]. This is manageable in negotiation but should be anticipated and pre-empted with documentation.

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#### 5. Caveats & Pre-Listing Recommendations

The Schedule above is constructed entirely from owner-stated figures and Layer 1 deterministic calculations. It is not yet CPA-attested, which is increasingly required by SBA preferred lenders before issuing a credit memo on transactions in this size range. Pre-listing CPA attestation typically costs $3,500–$7,500 and materially compresses the buyer's diligence period, accelerating close and reducing re-trade risk.

Specific items requiring action before market launch:

• Related-Party Rent / Lease Terms [INSUFFICIENT DATA]. If the operating real estate is owner-occupied or leased from a related party, current rent must be normalized to market. Without this disclosure, the SDE could be overstated (above-market rent reduces P&L profit) or understated (below-market related-party rent inflates P&L profit and will be re-cast downward in QofE). Broker action: confirm landlord identity, lease terms, monthly rent, and remaining term.

• Mileage Logs for Personal Vehicle Add-Back. Construct or reconstruct business-use documentation for the $14,400 vehicle add-back to defend against the typical 30–50% QofE haircut.

• Premium Documentation for Owner Health Insurance. Pull annual premium statements and W-2 box 12 reporting to support the $22,000 add-back at full value.

• Equipment-Fleet Condition Assessment. Buyer's CPA will calculate maintenance CapEx separately from D&A. A pre-listing fleet age / condition inventory protects against an adverse maintenance-CapEx adjustment that would compress the effective SDE below the Schedule's $563,268 [CALCULATED] figure.

• Written-Contract Verification on Recurring Base. The 60% recurring revenue figure is a major multiple-driver. Buyers will request proof — a sample of executed maintenance agreements covering a representative slice of the customer file. Without written contracts, the "recurring" framing is reframed as "repeat business," which carries a lower multiple premium.

Typical QofE Haircut Range — Industry Context. Across small-business HVAC transactions, the total QofE haircut applied to seller-presented SDE typically ranges from 5% to 15% depending on documentation quality. Industry benchmark — not specific to this Company; broker to verify against current comp data. For Desert Sun HVAC, with reasonably clean books and straightforward add-backs, the expected haircut range is the lower end (5–10%) — translating to $25,000–$50,000 of SDE impact and $81,250–$162,500 of asking-price impact at the 3.25x multiple [CALCULATED]. With the pre-listing actions above completed, this range can be compressed to 2–5%.

Asymmetric Add-Back Treatment. The Schedule includes only seller-favorable defensible add-backs — documented personal expenses, replaceable owner comp, verifiable one-time items. Aggressive add-backs (projected post-acquisition synergies, extrapolated growth, hypothetical cost savings) are explicitly excluded; they are appropriate inputs to the buyer's investment thesis but not to the seller's normalized earnings figure. The Advanced Normalization Schedule generated in Stage 3 will incorporate document-verified line items at deeper granularity but operates within the same defensible-only philosophy.

Missing inputs: Related-party lease structure, mileage-log status on personal vehicle, premium documentation status on health insurance, equipment-fleet condition inventory, and written-contract verification on the recurring-maintenance base — Impact: Each gap drives a portion of the 5–15% QofE haircut range; closing all five compresses haircut exposure to 2–5%, protecting approximately $50,000–$130,000 of asking-price value [CALCULATED]. Broker action: complete a five-item pre-listing supplemental intake covering each gap.

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