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CEOs

How Using Adjusted EBITDA Can Make Your Business More Attractive to Buyers

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Getting a better valuation is one of the most important considerations when selling a business. Using an adjusted EBITDA calculation can help enhance your company’s attractiveness by providing the buyer an accurate depiction of future cash flow. (For more on the basics, see What Is EBITDA, and Why Do Investors Care About It?).

The adjusted EBITDA calculation takes into account certain items that have no bearing on a firm’s actual operational costs including non-recurring or one-time expenses.

Due to the way private companies account for these items, the use of adjusted EBITDA is more typical of private deals.

“A private company’s expense structure may not reflect market compensation rates, and often are not reported in accordance with generally accepted accounting principles (GAAP) standards,” says John Weld, a managing director of Strategic Value Advisors. “In publicly traded companies, which are subject to GAAP accounting, such anomalies aren’t as prevalent.”

Aside from distinctions in size, the items that are included in the adjusted EBITDA calculation varies for every company depending on its payment structure and expenses.

Using the adjusted EBITDA calculation, companies can take out an extraordinary item including one-time litigation expenses or not factor that into a company’s ongoing expenses.

They can also take into account certain add-backs. “The adjusted EBITDA number is different due to certain add-backs, indicating what companies have to pay above the line to get to profitability,” says James Cassel, chairman of Cassel Salpeter & Co.

He explains that to get to net profits from EBITDA, companies have to add back the taxes, depreciation, amortization, and interest. For example, in the case of a family-owned business, the salary of a family member who is not active in the business might be added back in an adjusted EBITDA figure.  

Another potential add-back is cost savings based on expenses that can be eliminated after a merger happens and upon integration. These add-backs can be viewed as synergies in an M&A deal. For instance, a buyer might already have an accounting department. Or Cassel cites selling a widget software business that has its own CFO or has excess capacity. “As investment bankers, we try to show that, due to synergies, there are X dollars of savings,” Cassel says.

But, the problem lies in who gets the benefit of the saving. For CEOs, this might mean convincing buyers to pay for those synergies with the help of their advisors. Having to use powers of persuasion can happen in cases where the buyer might not want to pay for those synergies. Cassel cites an instance where a buyer’s analysis shows that the synergies reduce the purchase price from paying 7X EBITDA to a lower multiple.

There are no set rules as to which of these items need to be removed or added back into the adjusted EBITDA calculation. Thus it is important for sellers to work closely with their advisors to determine what goes into the computation to get the best price and valuation for their companies in an M&A deal.

“When it comes to adjusted EBITDA, this is often a matter of negotiation as to which items can be added back to the operating expenses of the company and which items are discretionary, extraordinary or non-recurring,” says Craig Dickens, CEO and founder of Merit Harbor Group.

“A good investment banker will construct a defensible rationale for add-backs and negotiate vigorously around these items; however, the best defense is to it’s best to run as clean an operation as possible leading up to a sale.”

Keeping a clean operation is a good rule of thumb for CEOs to remember — this means the less discretionary add-backs to EBITDA, the better it is for acquirer confidence.

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