EBITDA is an acronym that stands for earnings before interest, taxes, depreciation, and amortization. Owners should have a good grasp of this figure when they are talking to potential buyers.
Why Do Buyers Use EBITDA?
EBITDA is an easy-to-calculate approximation of a company’s cash flow, that allows buyers to compare companies without having to adjust for potentially differing accounting and financing decisions. Cash flow is important to buyers because it indicates a company’s ability to fund future growth, service debt and provide returns for owners. Business owners should understand the drivers, trends, and growth potential of their company’s revenue, costs, and EBITDA before speaking with buyers, as these can be some of the main components of a buyer’s acquisition criteria.
How to Calculate EBITDA
EBITDA = Operating Income + Depreciation + Amortization
Adjustments may need to be made to EBITDA to account for irregular and non-recurring items. Adjusted EBITDA reflects a figure that is not distorted by irregularities and more accurately reflects the true EBITDA that the acquirer is buying.
Every company is unique, and every industry has specific characteristics. These nuances influence the adjustments made to EBITDA to determine the appropriately adjusted EBITDA figure.
Common adjustments include:
- Personal expenses run through the business
- Dividend income
- Above-market owners’ compensation (private companies)
- Capital gains and losses from investments
- Gains or losses by foreign exchange
- Asset write-downs
- Non-operating revenue
- One-time gains or losses
- Non-operating expenses
- Unrealized gains or losses
- Non-cash expenses
- Litigation expenses
- Special donations
- Goodwill impairments
- Share-based compensation
How to Determine Valuation
Business owners can determine the valuation range for their business in several ways. They can have an investment banker or valuation specialist review their business and determine a likely EBITDA multiple range. This review will consider sales, assets, debts, inventory, and other variables that define value. Valuation work will be a portion of a broader engagement with an investment banker, which can be expensive. A valuation assessment performed by a valuation specialist may cost anywhere from $3,000 to $7,500.
Business owners can also get a sense for valuation by speaking with industry peers, doing research on multiples of comparable companies, and searching for relevant precedent transactions. When researching for comparable public companies, however, it is important to keep in mind that there will be significant discounts applied to companies that are smaller and that are private, because they are not as liquid. E.g. An industry with a large public player could have a 10x EBITDA multiple, while a smaller private company could still be as low as 4-5x.
Be careful not to get married to expectations using any of these methods. Ultimately, these will only provide directional guidance, as your company is only worth as much as someone is willing to pay for it.
A final, cost-effective alternative for assessing value is for business owners to ask the opinion of investment professionals that may be interested in acquiring their businesses.
If you are preparing your business for a sale and/or would like a professional opinion on the value of your business, please feel free to contact Tide Rock. Our team works with small business owners and operating leaders every day to structure majority sale deals that are flexible and help them achieve their personal and professional goals.