EBITDA
Earnings before interest, taxes, depreciation, and amortization — a common starting point for valuing a business.
01
What It Means
EBITDA measures operating earnings before financing and accounting decisions are layered on. Removing interest, taxes, depreciation, and amortization is meant to show what the business itself produces, independent of how it is financed or how its assets are depreciated.
In smaller owner-operated businesses, buyers often work with an adjusted figure — sometimes called Seller's Discretionary Earnings — that also adds back the owner's compensation and personal or one-time expenses.
Businesses are frequently priced as a multiple of EBITDA, with the multiple varying by industry, size, growth, and risk.
02
Why It Matters
The multiple gets the attention, but the earnings figure drives the price. A disagreement over which expenses are truly discretionary can move value more than a disagreement over the multiple.
Lenders look at the same number differently than buyers do. Debt service coverage is calculated from cash flow after realistic owner compensation and capital needs.
EBITDA excludes real costs. Interest, taxes, and capital replacement do not disappear because they are excluded from a formula.
03
Common Misconceptions
- "EBITDA equals cash flow." It ignores working capital changes, debt service, taxes, and capital expenditures.
- "Every add-back the seller proposes is legitimate." Recurring expenses necessary to operate cannot be added back.
- "A higher multiple always means a better business." Multiples reflect industry norms and risk as much as quality.
- "Depreciation is not a real expense." Equipment eventually needs replacing, and that cash requirement is real.
04
Questions to Ask
- How was EBITDA calculated, and which add-backs are included?
- Are the financial statements reviewed, audited, or internally prepared?
- What does earnings look like after paying a market-rate manager?
- What capital expenditures are needed over the next few years?
- What multiple is typical for this industry and size, and why this one?
05
Related Reading & Resources
The most successful real estate decisions often involve collaboration between several professionals working toward the same goal. Understanding each person's role helps you ask better questions and make more confident decisions.
06
Other Business Sale Terms
- Asset SaleThe buyer purchases specific business assets rather than the legal entity that owns them.
- Stock SaleThe buyer purchases the ownership interest in the entity, and the business continues intact.
- GoodwillThe intangible value of a business beyond its tangible assets — reputation, customers, and earning capacity.
- Seller FinancingThe seller carries part of the purchase price as a note, and the buyer repays over time.
- Non-Compete AgreementA negotiated limit on the seller competing against the business they just sold.
- Letter of Intent (LOI)A preliminary outline of the key deal terms before definitive documents are drafted.
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