We live in a world of acronyms. They’re the shorthand we use when we’re communicating with industry peers, a few letters that can describe a complex process or concept.
But when everyone doesn’t speak the language, acronyms can become a barrier rather than a short cut. In the world of mergers and acquisitions, we routinely use the acronym EBITDA. Some call it E-BIT-D-A. But most simply say E-bit-dah.
When it comes to selling your company, virtually everyone involved in the transaction will know the term, which is shorthand for Earnings Before Interest, Taxes, Depreciation and Amortization. I say “virtually” everyone, because sometimes the only people who don’t know what EBITDA means are the business owners looking to sell their companies.
EBITDA is not a calculation that business owners would normally find useful. It’s not something that will show up on their balance sheet. It’s not revenue or expenses. It doesn’t hit their bottom line.
But when it’s time to sell, EBITDA becomes the building block for constructing the market value of a business. It is a number that measures a company’s profitability before deductions (interest, taxes depreciation and amortization) that are not considered part of the firm’s operating costs. And it’s relatively easy to calculate.
In the M&A world, we frequently say things like “XYZ Company should be valued at seven times EBITDA.” In that context, EBITDA is considered by many as a good way of comparing the valuation of one company versus another, even though it is not a complete view of a company’s financial health.
Yes, EBITDA can be confusing, and it is not without its critics. But it’s important that anyone contemplating the sale of his or her business understand it, because they will see it again and again as they move forward in the sales process.
Since EBITDA does not necessarily reflect a company’s profitability, a valuation based on EBITDA can sometimes be a pleasant surprise for owners as illustrated in this example from Investopedia.com involving a retail company:
As you can see, EBITDA, in this example, is twice net income. So if the company’s value were determined to be seven times EBITDA, it would be worth $280 million, which might indeed be a pleasant surprise for the owner.
As I noted earlier, computing EBITDA is the easy part. If you are interested in selling, you will want to engage a skilled M&A advisor. He or she can best position your company to generate top EBITDA multiples by approaching a select mix of strategic and financial buyers to compete for your company. At Allegiance Capital Corporation, this is what we do best.
By explaining EBITDA, I hope to provide at least a core understanding of what this measure is and to demonstrate why we at Allegiance Capital feel educating our clients and prospective clients is one of the most important things we do.
Once we’ve explained the core components of an M&A transaction, we work with clients to make changes that will increase the value of their company and the multiple of EBITDA that they can expect acquirers to offer. And we will continue to guide them during every step of the complex process of selling their business.
If you’d like to learn more about what goes into selling a business, we have a great book that we’ll provide you for free. It’s called Street-Smart Moves for Selling Your Business by Joe Aberger. This small book addresses 29 topics that are critical to selling a business like yours. Be sure to Sign Up Now.
And, in the meantime, if you have questions, feel free to call me at 214.217.7732.
About the Author
David J. Mahmood
Founder and Chairman
Phone: (214) 217-7750