Understanding Adjusted EBITDA: A Key Metric in Selling Your Business
When selling a business, one of the most critical metrics that potential buyers look at is Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). This commonly used measure of business performance is often a foundation for determining a company’s valuation. However, unlike standard accounting measures, there are no set guidelines for calculating Adjusted EBITDA, making it a subjective metric that can vary significantly depending on adjustments.
Let’s take a closer look at what Adjusted EBITDA involves, how it’s calculated, and best practices for sellers and buyers to ensure fair and accurate assessments.
What is Adjusted EBITDA?
EBITDA provides a snapshot of the cash earnings a business generates by excluding financing, tax obligations, and non-cash accounting adjustments (like depreciation and amortization). Adjusted EBITDA goes a step further, removing expenses or revenue streams that don’t reflect the business’s ongoing core operations. This can provide a clearer view of the true economic profit potential of the business, making it especially useful for buyers evaluating a potential acquisition.
Common Adjustments to EBITDA
- One-Off Events: Unusual expenses—like lawsuit costs, natural disaster recovery, or other significant but rare expenses—are typically removed to avoid distorting profitability.
- Overpaid or Underpaid Employees: Adjustments are often made to reflect market-rate salaries, especially for key roles, if compensation is either above or below industry standards.
- Personal Expenses: In smaller businesses, owners sometimes include personal expenses on the P&L (e.g., meals, travel, home office, and car expenses). Adjusting EBITDA to remove these non-business expenses can provide a truer financial picture. In smaller sales, the owner’s salary may also be added back to arrive at a measure called “Seller’s Discretionary Earnings” (SDE).
- Non-Core Revenue Streams: Revenue from side businesses or unrelated ventures may be subtracted, as these are not essential to the core business’s operations.
- Intercompany Transactions: If a business has multiple entities, intercompany revenue and expenses that do not reflect genuine economic activity should be adjusted.
Best Practices for Business Sellers
As a seller, presenting a clear and fair Adjusted EBITDA can help attract serious buyers and streamline the due diligence process. Here’s how to make the best adjustments:
- Know What Makes Sense: Since you know your business best, identify adjustments that accurately reflect its operational value. Ask yourself, “Would these adjustments pass scrutiny from a third-party Quality of Earnings (QofE) provider?”
- Be Transparent: Buyers appreciate honesty and transparency, especially when it comes to financial adjustments. This openness builds trust, avoids later disputes, and can help prevent delays in closing.
Best Practices for Business Buyers
For buyers, understanding Adjusted EBITDA is essential to assess a business’s potential accurately. Here’s what to keep in mind:
- Scrutinize Adjustments: Since sellers aim to maximize EBITDA, it’s important to ask, “Are these adjustments genuinely non-core to the business I’m buying?” and “Will these adjusted expenses or revenue streams recur under my ownership?”
- Perform Your Due Diligence: Conduct a Quality of Earnings analysis to ensure the reported Adjusted EBITDA aligns with the true economic performance of the business.
Why Adjusted EBITDA Matters When Selling a Business
Adjusted EBITDA offers valuable insights into your business’s cash flow and profitability. If you’re preparing for a sale, ensuring your Adjusted EBITDA is well-documented, reasonable, and transparent can help attract qualified buyers and support a smoother sales process.
At 1-800-Biz-Broker, we understand the nuances of Adjusted EBITDA and the role it plays in maximizing your business’s sale value. Whether you’re ready to sell or simply exploring your options, our team can help you navigate this essential metric and guide you in showcasing your business’s financial strength.
Thinking about selling? Contact 1-800-Biz-Broker today to see how we can help you present your business in the best light and achieve a successful exit.
