Valuing Your Business – Why EBITDA Matters
Whether your business is based here in Toronto or elsewhere in the Canada, in most instances, buyers derive their value based on a multiple of the company’s earnings before interest, taxes, depreciation and amortization or “EBITDA” as the parlance goes.
While EBITDA may be a word that gets tossed around commonly in the M&A community, it actually can vary significantly depending on who is calculating it and the methods used to do so. Put a multiple on the variance of EBITDA calculation in either direction and value of your business is significantly impacted. So, let’s discuss what EBITDA actually is and why it matters.
In simple terms, EBITDA is a metric used to evaluate a company’s earnings without having to factor in financing activities, accounting activities or tax decisions. It is a picture of what the company’s earnings look like if operated for maximum efficiency without any consideration of tax mitigation.
EBITDA is calculated by adding back one-time non-recurring expenses and taxes in addition to the non-cash expenses of depreciation and amortization to operating income. That said, it is not uncommon for a business owner to have a ‘net income’ that varies from their formal EBITDA calculation depending on how they allocate certain expenses.
If you are pursuing the sale of your Toronto based business and you hire an investment banker they will typically work with you to identify all the potential “add-backs” to EBITDA. This includes everything from research and development, to capital improvements, personal expenses and other one-time capital expenditures.
Calculating EBITDA creates a delicate balance between being aggressive and being realistic. As a seller you want EBITDA to be as high as possible to drive maximum value, but any sophisticated buyer will ask for an explanation to all the add-backs. The add-backs have to be defensible or the buyer will not accept them, thus reducing EBITDA by the amount of the rejected add-back.
To truly feel confident about your recast EBITDA presented on your income statement it may behoove you to have a CPA vet all the add-backs to ensure they are truly called for.
Once a buyer has accepted the EBITDA value as legitimate how do they apply a multiple in order to value your business? The answer is multi-pronged and varies greatly but there are certain guidelines most buyers adhere to.
Industry is one area that greatly affects multiples significantly. Technology companies, especially ones with impactful intellectual property, can drive EBITDA multiples into the double digits while distributors who often have lower EBITDA margins, can sometimes sell for less than four times EBITDA. While not all companies are valued exclusively on an EBITDA multiple value, EBITDA does almost always play a significant role in assessing value.
Comparable transactions are another method used by buyers, but note, these can be dubious because no two companies are truly alike. Some buyers compare public multiples and then discount them by 30% to 50% depending on the size of the business for sale – again, a practice that varies buyer to buyer. These methods are easy to relate to a sales price, but the most common valuation methods used by buyers are their own internal metrics based specifically on their own goals and strategy.
Most buyers, especially private equity groups, have a targeted internal rate of return and they price the business accordingly. That pricing is typically based on EBITDA, so if you are looking to maximize value that number with the funny sounding acronym is of paramount importance. The best thing you can do is work with professional advisors that can help you calculate EBITDA in the best possible by light while being truly defensible to buyers of all types.