The amazing value of credits to EBITDA

John D. Wagner

Two years ago, this column covered the concept of adjustments to EBITDA, and how valuable they can be when boosting the overall value of your company in the event of an acquisition. EBITDA is an acronym for Earnings Before Interest, Depreciation and Amortization. It is a commonly used GAAP financial measure. (GAAP stands for Generally Accepted Accounting Principles.) EBITDA is so frequently cited because it is viewed as a proxy for operating cash flow. What are credits to EBITDA? Let’s say that you lay out cash for non-recurring expenses in the fiscal year before you sell your company, or in the trailing twelve months’ financial performance before you take your company to market. If those expenses are not capitalized, then they are probably* eligible to be added to a figure called adjusted EBITDA. Put another way, any one-time outlay of cash you made for non-recurring expenses could have been added to your earnings, so you should get a credit for them at the time of sale. (Note that adjusted EBITDA is a non-GAAP financial measure.)

Just above, I said one-time expenses can probably be added to EBITDA, and I added an asterisk. That asterisk is there to indicate that not all the amounts you (advised by your investment banker) claim as credits to EBITDA are guaranteed to be accepted by the acquirer. Indeed, some of the most “interesting” conversations to be had with a potential acquirer are over the acceptability of credits to EBITDA. Candidly, there is a fair amount of horse trading that goes on in this acceptance/denial process. That’s because some credits to EBITDA are in gray areas of acceptability, such as the monetary value of points gotten through credit card pro- grams which will accrue to the acquirer, or what expenses are truly company expenses versus personal expenses run through the company’s books. Cash paid (and not capitalized) for a new roof? That’s a slam-dunk…But lease payments made for your part-time-worker/son-in-law’s pickup truck…not so much.

What effects can credits to EBITDA have on your value? They are truly meaningful. That’s because every dollar add- ed to EBITDA has a multiplier effect on your value. For ex- ample, using a valuation multiple of 5x EBITDA, a company booking $4,000,000 in EBITDA would sell for $20,000,000. But let’s say you found just $300,000 to credit to your adjusted EBITDA. That would boost the EBITDA to $4,300,000, and it would boost the business value to $21.5 million, instead of $20 million, a $1.5 million lift. So, it’s worth taking a long hard look at possible credits.

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A word of caution when searching for credits to EBITDA. Smaller amounts (sometimes referred to as “ash and trash”) should not be added as EBITDA credits, because it looks    as though you are nickeling and diming the acquirer. Adjustments to EBITDA of less than $1,000 would be looked at askance by an acquirer. Think more of $5,000 as the low end of the threshold for inclusion.

Work with your M&A advisor to determine adjustment to EBITDA, but here are some examples:

1.  Owner salaries and bonuses: if the going rate in your area to replace you is $200,000 per year, and you’re drawing $300,000 per year, that $100,000 differential is arguably eligible as an adjustment to EBITDA.

2.  Personal owner expenses: Family members on the pay- roll who will depart under new ownership and don’t have to be replaced, are common EBITDA credits. The same with club memberships, or things like family’s cell phone plans that the acquirer won’t pay for under new ownership. Those may be credits too.

3.   Non-recurring professional fees: Legal fees or a settlement of a lawsuit that are one-time events; consulting fees that are one-time expenses…these are valid credits to EBITDA.

4.  Infrastructure, equipment, software, IT investments: If these are expensed, and not capitalized, these are valid credits to EBITDA. (In the case of, say, software development that is a one-time expense, if it is being amortized, then it would not qualify as an adjustment to EBITDA.)

The old cliché “don’t leave money on the table” couldn’t be more true here. For every dollar in unclaimed EBITDA expense, you are losing 5x, 6x, sometimes 7x of that amount off the final purchase price of your company, depending on the multiple paid for your company. You just need to prevail in the discussion of whether the credits are acceptable or not, and for that, your investment banker is a good source of advice.