In my last article, I discussed the EBITDA method of valuation as it relates to the very first step in developing an exit strategy. Every business owner should understand this method and know the current EBITDA of their company, and the future EBITDA that will be needed when they are ready to sell.
To review, EBITDA is simply the adjusted earnings of a business before interest, taxes, depreciation, and amortization multiplied by a multiple that is relevant for the company’s particular industry and size.
First of all, EBITDA must be adjusted either up or down for income or expenses that have been incurred prior to a sale but would not occur after the sale of a business in its normal day to day operations. These adjustments can take many forms but below is a very small sample of some typical adjustments.
- Excessive compensation to owners or other employees
- Country club , sports tickets, or other expenses not necessary to running the business
- Excessive insurance paid to owners or others
- Discounted sales prices to friends
The above list can be very long. There are two main reasons adjustments are necessary.
- Buyers need to know how the company looks financially under normal operating conditions
- Buyers are trying to compare similar companies to your company to be sure they are making the best financial decision.
Secondly, after EBITDA is adjusted, it is multiplied by a multiple to arrive at an estimated value for your business. “The multiplier typically ranges from 4 to 6 times adjusted EBITDA, particularly for financial buyers. However, the multiplier has gone below 4 and substantially above 6, depending upon whether it is a buyer’s market or a seller’s market for the sale of businesses. A multiplier above 6 is more typical for a strategic rather than financial buyers (Mills, p.56).”
Every business owner should know the approximate value of their business using the EBITDA method.
*Mills, Jerry L., (2013), The Exit Strategy Handbook