Finance
EBITDA
Earnings Before Interest, Taxes, Depreciation, and Amortization: a proxy for operating cash generation. The most common valuation metric in small-business M&A because it isolates operating performance from financing and accounting decisions.
EBITDA strips out financing decisions (interest), tax structure (taxes), and accounting estimates (D&A) to focus on the operating profitability of a business. Often used as a valuation multiple for M&A.
Adjusted EBITDA further normalizes for one-time items (legal settlements, owner-related expenses, transition costs) to reflect the business's run-rate profitability.
The standard add-back categories in owner-run small businesses: (1) owner compensation above or below market (recasting to a market-rate manager wage), (2) one-time items (legal settlements, moving costs, insurance recoveries), (3) personal expenses run through the business (owner's car, family phone bill, travel that isn't business), and (4) pro-forma normalisations (mid-period acquisitions annualized, rent adjusted to market for related-party leases). Each requires supporting documentation; every add-back a buyer discounts is a dollar off the sale price at the applied multiple.
The valuation-multiple math is why EBITDA drives seller behavior. A business selling for 5× EBITDA sees every $1 of durable EBITDA add-back become $5 of purchase price. That's the incentive owners have to substantiate add-backs correctly (worth real money) and the incentive buyers have to discount aggressive ones (also real money). QoE analysts split the difference on well-documented add-backs and delete undocumented ones outright.
EBITDA is NOT cash flow. It ignores working-capital changes (accounts receivable growth eats cash without touching EBITDA), it ignores capex (a machine-shop's EBITDA looks great until you notice the $500k lathe needing replacement), and it ignores debt service. For a buyer underwriting a deal with debt, the more relevant metric is EBITDA − maintenance capex − working capital investment, sometimes called owner earnings or free cash flow — the number the debt service must clear.
Common pitfalls
- Using EBITDA as a proxy for cash flow without accounting for working capital changes and capex
- Buyers often discount aggressive 'add-backs' in seller-prepared adjusted EBITDA
- Presenting add-backs without documentation — undocumented ones get deleted, and the seller loses that dollar times the multiple
- Ignoring capex-heavy business models — trucking, manufacturing, restaurants — where 30-50% of headline EBITDA is really maintenance capex, not distributable cash
- Confusing TTM (trailing-twelve-month) EBITDA with pro-forma EBITDA in a deal negotiation; the two numbers should be reconciled explicitly, not blended silently
Related service
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