EBITDA (earnings before interest taxes depreciation and amortization) is used by buyers to estimate the cash flow of a company. They remove interest, because that is only correlated to how you have chosen to capitalize the company, taxes because that varies based on the owners, depreciation because it is a non-cash expense, and amortization because it is a non-cash expense. EBITDA is used to calculate the value of the company by multiplying EBITDA by an EBITDA multiple. Ultimately this means any improvement to EBITDA has a big impact on enterprise value. Below are a few rules of thumb for positioning / maximizing EBITDA prior to a sale:
- Personal expenses- We understand tax planning. We understand there may be some expenses that are run through the business that are exclusive to you. We can present these as addbacks, and eliminate these expenses thereby increasing EBITDA. Some of these addbacks are very easy to explain. For example, personal vehicles, country club memberships, and non-active family member salaries are examples of expenses added back to EBITDA. Simply be careful to document these personal expenses the two to three years prior to taking the company to market. Other addbacks are more difficult, for example if the expense could be viewed by buyers as necessary, it is best to eliminate the expense at least a year in advance of taking the company to market. Examples:
- You choose to advertise more than is necessary (for any number of reasons). It is difficult to convince a buyer that the additional advertising spend wasn’t responsible for some part of your car counts, average ticket, etc. Cut back your advertising to what is necessary at least the year before, and ultimately there won’t be any argument.
- You over pay an individual within your organization. This can be tricky, often this individual is a family member. Depending on the position, it can be difficult to convince a buyer that this isn’t the fair market salary for the position. This is particularly difficult addback to win if the person is a key member of your operations team (for example your first employee, or DM). If possible, reduce their compensation to fair market at least a year in advance of the process and remove the debate with buyers.
- Operating Expenses – Check your operating expenses to make sure you are as lean as possible. Any reductions in costs that flow to the bottom line will increase enterprise value by a multiple of the change.
For example, if the company was valued at 4x EBITDA, a $100,000 improvement to EBITDA will increase the enterprise value of the company by $400,000. We work hard to understand the financials of each of our clients, to reflect the highest, accurate, EBITDA possible. This presentation (making it believable, and credible) is a key to maximizing value, and is a key skill set of Black Iron Advisers.