ebitda adjustments + 5 expense categories you should review

When assessing how to value a business for an M&A deal, buyers will typically focus on adjusted EBITDA as their primary metric. EBITDA looks at the business’ profitability from its core operations before the impact of capital structure, and non-cash items like depreciation are taken into account. Adjusted EBITDA removes various one-time, irregular, non-recurring items that are not related to the day-to-day, ongoing operations of a business. Since companies are often valued based on a multiple of Adjusted EBITDA, these expense items directly impact the value of your business. For example, if a business is valued at 6.0x EBITDA then simply adding back $500,000 of irregular expenses adds $3 million to the purchase price. This is why buyers pay very close attention and may disagree with certain adjustments. For more detail on this topic, please refer to our previous blog, “Understanding EBITDA and Normalizing Adjustments”.

The following are five most common EBITDA adjustments:

#1 Owner salary & Compensation

If the owner’s salary is deemed to be above market-rate levels, an add-back for any excess salary would be appropriate. Salary collected by spouses or family members that are not active in the business will also be removed.

#2 Other owner-related Expenses

If the owner has personal or business expenses that would not continue after the deal, they would be added back. Examples include personal vehicles, insurance, travel, entertainment, and club memberships. These items might be on the income statement purely as a tax mitigation strategy and are not essential to operate the business.

#3 Rent expenses

If a company pays above or below market rent, the income statement should be adjusted accordingly to reflect a true market rent level. If the real estate is owned by the business, but it is not critical to operations, any related expense (insurance, maintenance) would be removed from EBITDA. 

#4 Gaps in the Management Team

Should a buyer need to hire new executives to fill out the team, there would likely be a negative adjustment to EBITDA for salary and other items related to such hires.

#5 Legal/Litigation Items

One-time or highly unusual lawsuits are considered to be add-backs. Importantly, this would not include typical ongoing legal expenses that are common to a business. 

Are you considering an exit or recapitalization and have questions about EBITDA addbacks and their potential impact on the value of your business?  If so, please contact us.