M&A Insights – Mark Young, Managing Partner, CKS Advisors
Welcome to the July 2019 edition of M&A Insights. Our goal at CKS Advisors is to help you stay up-to-date on the current Merger and Acquisitions climate.
This edition will be the first in a two-part series on valuing a business. Buyers commonly value businesses by determining a company’s Cash Flow (EBITDA) and applying a Multiple to that Cash Flow.
This month we will discuss EBITDA and more specifically, the importance of Adjusted EBITDA in valuing a business. Next month, we will discuss Multiples and more specifically, the factors that influence the Multiple a buyer may use to value your business.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a more accurate method of showing the operational cash flow of a business by excluding non-operating factors like interest expenses and taxes as well as eliminating the impact of non-cash expenses including depreciation and amortization. More simply, EBITDA presents “normal” operational earnings, allowing prospective buyers to accurately evaluate and compare companies.
What is Adjusted EBITDA?
Once EBITDA has been calculated, a seller should then determine the adjustments that would show the “true” cashflow of the business (AKA “Adjusted EBITDA”). These adjustments are made to account for owner-related expenses which a buyer likely wouldn’t incur while owning the business. Adjustments can include owner’s discretionary expenses such as above market compensation for the themselves and others, as well as non-recurring items/one-time expenses such as litigation expenses, professional fees, non-market rents paid, and real estate expenses paid by the company. A detailed review of the Company’s financials is important in order to capture all of a business owner’s adjustments to which they are entitled, given the potential impact they can have on value.
If time permits, we recommend that owners review and minimize owner-related expenses prior to a sale so the financial presentation is cleaner. This leaves fewer items for a buyer to scrutinize during their in-depth review of the company’s financials. In any situation, owners should have detailed documentation in order to support the legitimacy of their adjustments.
Why is Adjusted EBITDA Important?
The overall impact of not including these adjustments to a company’s market value calculation often leads to a somewhat significant positive impact to the price a seller receives. For example, if a company’s EBITDA is $2,000,000 combined with a multiple of 5 times, the before EBITDA adjustments value would be $10,000,000. If adjustments totaled $200,000 and were included in an Adjusted EBITDA total, there would be a $1,000,000 increase in the purchase price the seller would receive. Therefore, the exercise of adjusting EBTIDA is a worthwhile exercise for most business owners.
What Should I Do Now?
There is an Art and a Science component to calculating and negotiating Adjusted EBITDA. Talk to your professionals, particularly an Investment Banker, who can assist you in presenting your company’s true cash flow. We are available to answer any questions.
Stay tuned next month for Part 2 of this discussion on valuation.
If you would like to learn more about the M&A market or are ready to explore options, we would be glad to meet. Please contact me at 480-351-8533 or email@example.com.