EBITDA is a term with a time-worn, clinical definition. It stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Why is it a term of such keen focus? Because the majority of acquirers look at EBITDA as a proxy for cash flow; it signals a company’s success by expressing how efficiently it turns net sales into earnings, while eliminating the non-operational side of the business, like interest, depreciation, and taxes. The expression of a company’s earnings efficiency—EBITDA as a percent of sales—is a key performance indicator, which is just as important as another KPI, which is OPEX as a percent of sales.
Although EBITDA uses information from financial statements produced using General Acceptable Accounting Principles (GAAP), it is not considered a GAAP measure, since the definition of what EBITDA includes or excludes can vary from company to company.
There are, however, five types of EBITDA. The first of the five is standard EBITDA, described above. But it’s an abstract concept until it is expressed for a defined period of time.
That leads to the second type of EBITDA, which is the EBITDA from your last fiscal year. This is most often used as a reference point to see how fast you are growing (or not) in the months after your most-recent fiscal year ended.
The third type of EBITDA is Trailing Twelve-Month EBITDA, also called TTM EBITDA or LTM (last twelve month) EBITDA. Ideally, your TTM EBITDA is rising month-over-month as you go into a close, and you and your investment banker can ask for the purchase price to climb accordingly. (Believe me, if TTM EBITDA is falling going into the close, the acquirer will push to have the purchase price reduced that’s called repricing after LOI.)
Some acquirers don’t welcome dynamic deal pricing. They want to offer a set price in their LOI, based on a multiple of a recent EBITDA, rather than endure the unpredictability of a floating purchase price.
A fourth type of EBITDA is called adjusted EBITDA. It is very often used as the TTM EBITDA figure, if the acquirer and seller mutually accept the adjustments. Seller’s adjustments almost invariably move the EBITDA higher. (Remember, in today’s 5X EBITDA market, adding just $100,000 in adjustments can increase the purchase price $500,000.) Typically, acceptable adjustments to EBITDA are non-capitalized, non-recurring expenses that won’t be incumbent on the new owner, or OPEX that won’t reoccur. (A widely accepted adjustment to EBITDA is the compensation of employees who are deemed non-essential, who will retire when the company is sold, and whose positions will be eliminated.) Adjustments to EBITDA need to be proposed by the seller to the acquirer through the investment banker. Acceptance of the credits is not guaranteed; it’s part of the deal that’s actively negotiated.
The fifth type of EBITDA, sustainable EBITDA, is a very active topic of conversation today. That’s because the EBITDA you are experiencing now is likely inflated due to supply chain constrictions, commodity price run-ups, “COVID bump,” and now inflation. You may have the same gross profit margins that you did a year or two ago, but you are churning more net sales dollars, resulting in more EBITDA. The acquirer doesn’t want to price on an inflated EBITDA. They will want an EBITDA that can be sustained after normalization of these “wild card” factors, e.g., after supply chain issues, price volatility, and COVID-19 are backed out. Some sellers (and even some acquirers) believe that supply chain, commodity issues, and COVID-19 aren’t going away soon. Sellers especially hold that the purchase price of companies bought in this odd time—where we don’t know if these influences will continue, nor for how long—should not be overly discounted to so-called sustainable levels. As a seller who holds that position, you can (with a good investment banker) largely defend your higher EBITDA. At our firm, we have a model that examines the EBITDA in light of these wild cards, careful to factoring in organic growth that would have occurred in any market. Using a model like this, you the seller may not get a multiple applied to 100% of your TTM EBITDA, but every dollar you argue for successfully is five dollars in your pocket with a higher purchase price.
John Wagner is a managing director at 1stWest Mergers & Acquisitions, which offers a specialty practice in the LBM sector. Reach John at j.wagner@1stwestma.com
