Adjusted EBITDA: Using Add-Backs to Maximize Your Company's Enterprise Value

Michael Lamm

The sale of a service business like a collection agency or collection law firm is a complex process to be sure. But like a lot of other transactions involving a buyer and a seller, the question of price (or value) is typically front and center in both parties’ minds.

As my colleague, Mark Russell, noted in a blog last week, if you’re the seller it’s important to identify your financial goals and value expectations if you’re considering selling the company you’ve built. That said the process of selling a business is a negotiation between two parties, and a common method buyers use to determine the enterprise value of a company is applying a multiple to adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Therefore, when talking to a buyer about selling your company it’s important to understand EBITDA and whether you can make any adjustments to it to realize the highest possible purchase price.

To be clear: EBITDA is one of the key financial performance indicators a buyer will use to assess the value of a service business. Sellers will tend to “normalize” or “adjust” EBITDA to account for certain expenses that would not continue post-transaction. As a potential seller it is important to think through what can realistically be added back to your bottom line between point A (you as the current owner) and point B (after the deal is done).

A few tips before you enter into discussions with a buyer when it comes to adjusted EBITDA:

1. Determine what adjustments genuinely apply to your businesses earnings on a year over basis. (A word of caution: don’t try to add back the entire kitchen sink; buyers will see right thorough this maneuver.) A few examples of legitimate add-backs:

a. Cousin “Suzy,” a company employee who receives a $40k salary plus healthcare benefits from the company, but will no longer be employed (her responsibilities would be assumed by the other personnel within the company – no additional cost to buyer). post-transaction.

b. One-time expenses that run through the P&L, like the shutdown of a call center facility.

c. The “Chicago Cubs” ticket costs that are a personal benefit to you, not the business. However, if you use the tickets frequently for business development purposes, a buyer may want to continue that cost going forward.

2. There may also be unaccounted expenses on your P&L where a buyer would incur additional costs post-transaction. For example, many privately owned service companies do not have a dedicated CFO or Controller. A buyer may need to apply a “negative adjustment” to account for the additional salary/benefits expense associated with hiring that individual. Put yourself in the buyer’s shoes and think about how they are going to view the current expense structure going forward.

3. Are you active in the business? If not, there is an argument that you can add-back your compensation and the other benefits you derive from the business. A buyer will heavily scrutinize this adjustment to determine your current role and responsibilities. In some instances, owners underpay themselves on a base salary basis. If you are active in the day-to-day operations of the company but are not receiving a fair market salary, expect a negative adjustment to earnings to bring your salary up to a fair market value post-transaction even though you expect to continue with the company and are willing to retain your current base salary. A buyer will need to make this change in the event they need to replace you at some point in the future.

4. Trying to add back historical or anticipated “one-off” capital investments is really difficult. For example, even if you just upgraded work stations, implemented a new dialer system, or paid SAS70 certification fees, a buyer will often view these expenses as the “cost of doing business” in this industry.

5. You can expect that a buyer will want to understand adjusted EBITDA trends for at least the last 3 years and see a trailing 12 months income statement and projected adjusted EBITDA calculation for the current and following year. Prepare yourself to be able to produce these documents in a timely manner. The longer it takes you to deliver these figures, the more a buyer will be concerned about the strength of your company’s financial controls.

If you are trying to calculate adjusted EBITDA for your business and would like some assistance, give me call or shoot me an email. I’d be happy to walk you through it.

Michael D. Lamm advises owners on their growth and exit strategies for Kaulkin Ginsberg’s Strategic Advisory team. Michael can be reached directly from Kaulkin Ginsberg’s Philadelphia office at 240-499-3808 or by email. You can also read his blogs on insideARM.com.