What is EBITDA? Why is an EBITDA Multiple Important?

Sometimes there is confusion about EBITDA or "Earnings Before Interest TaxesDepreciation and Amortization" and why an EBITDA multiple is important in a company valuation.

Let's start with explaining EBITDA and then we will understand how it's important in determining the value of a company. Many people are familiar with the term, but a business owner may not understand how to calculate EBITDA for their own company. One of the purposes of calculating EBITDA is to get to a cash flow number which can be compared to others in your industry. It is also a number which a buyer would expect to earn from the company after the sale.

First, you need to start with your earnings, which could also be called net income, income after taxes, profits, profits after taxes. You get the idea; it's basically your bottom line or what you have left over from your company revenues after you take out all of the "reasonable" expenses. Not the expenses for your Tesla, vacation home or extravagant eating habits. 

Ok, so now we have the "E" and "B" - earnings before...

Next you add back some items - "I" - such as interest on bank loans or debt and - "T"- taxes. You also want to add back - "D" and "A" - depreciation and amortization which are basically non-cash expenses.

The point of EBITDA is to compare companies by the same metric, so you can see the profitability and cash flow of the company compared to other companies in the same industry. This means we eliminate factors a business owner has discretion over, such as the type of debt financing and capital structure, whether it's taxed as an S-corporation or C-corporation and if the assets are depreciated using acceleration methods such as Section 179 depreciation.

Buyers will also look at adjusted EBITDA, which is calculated by reviewing the financial statements and determining if there are owners’ discretionary items such as higher salaries for management, perquisites such as cars and any other non-operating items. Non-operating expenses are not necessary for the business to function, such as vacation homes, first class travel, sports season tickets and such. There are adjustments for non-recurring income or expenses such as loss from a fire or income from the sale of certain assets. These items are not likely to happen again. Basically a buyer would look to “normalize” or adjust EBITDA for all of the expenses and/or income, which may not continue into the future. Once you eliminate some of these items then you can look at your company's EBITDA and apply a multiple derived from industry transactions, mergers and acquisitions.

In the valuation of the company there are three methods to consider and one of them is the market approach. This approach uses various market multiples, basically what companies have sold for in the open market, to determine the value of company. One valuation multiple is the sales price divided by EBITDA or also known as an EBITDA multiple.

For example, buyers may pay six to seven (6-7) times EBITDA in a certain industry. This means that the value of the company would be in the range of six to seven multiplied by your company’s EBITDA number. How do you determine the multiple? Well valuation experts have extensive databases of transactions. We search based on the industry code and then will select multiples for sales of companies similar to your business in size, location, revenue, profitability and other factors. We work to find evidence of other sales which would indicate what your company may sell for in the open market. Of course it's not always a simple calculation because a buyer would consider many factors in order to determine what they would pay for your particular company, such as synergistic elements, but it does give you an idea of the cash flow and value.

In the sale of a business there may be other adjustments regarding balance sheet items. For example, if you have excess cash in the business in the form of investments or cash in the bank, not needed for the operations, you could add this cash to the value of the company. A buyer would not take the cash with them at the point of sale. There may also be some liabilities or debts for which the buyer will not assume, such as debts owed to shareholders. So there could be additional adjustments to the value, which a valuation expert could help you understand during a formal valuation process.

In order to plan for a future exit of your business it's not only important to understand the market multiples in your industry but also understand your company’s EBITDA level historically as well as earnings going forward. Most buyers will want to see three to five years of financial information, so it is best to know what trends they will see before you start the selling process.

If you'd like to know more about how to value a company or if you are selling a business and have some questions about the value give me a call at 314-541-8163.

This information should not be construed as investment or legal advice, just one expert’s perspective.

How Does a Divorce Attorney Know When to Hire a Valuation Expert?

Family law attorneys often ask us if they really need a valuation and when should they contact and hire an expert.

Here are some things to consider. What do you know about the business? Understanding whether you need a valuation has to do with several factors, some of them are about the business and some of the factors are about the strategy for testimony regarding valuation and maintenance issues. Some simple questions you can ask your client are in reference to profitability, is the company making money or profitable? Has the revenue stayed the same as the past couple years or is it significantly different, either up or down? Does the owner receive a salary from the company or possibly distributions? You can also ask whether the company is a start-up or if there are any trademarks, patents or proprietary systems. See if you can get 3-5 years of financial information such as balance sheets and income statements or, at a minimum, the company’s tax returns. This will give you a better idea of the operational history and you can share it with an expert to give them an opportunity to understand the complexity and scope of the valuation.

Why should you care about these questions? Typically these are the areas of contention in a divorce. The parties will disagree on what the future of the company means to the value, more importantly one party may think the other spouse is destroying the business prior to the divorce – in order to lower the value. There are cases where the person operating the business will funnel money out of the business or invest heavily in new equipment, which may be unnecessary to the operations. In other cases the owner will pay themselves a hefty salary or, conversely, a very low salary given the responsibilities, either way the compensation may need to be adjusted. When you adjust salary you need to consider the issues surrounding “double dipping”, which is simply using one number for compensation when determining the value of the business and using a different number for the calculation of maintenance.

What does the valuation have to do with strategy? Strategically you may want a valuation if the other party has already hired an expert, or if there is any concern about whether a business asset is marital or separate, or if there are several companies involved and the business structure is complicated. Typically when the parties get divorced both sides start to have completely different views of the value of the company, which makes it necessary to hire an expert to determine a supportable value of the company. Your expert is there to provide a defendable valuation opinion, not the highest or lowest number which benefits the client.

Normally you can contact a valuation expert, discuss some of the specifics of the company or the situation and then determine what type of valuation is necessary given the facts and circumstances. It's not always easy to determine whether you need a valuation but you can also hire experts to just review the documents. They will take a look at the specific issues you've identified and see if there's a better way to go about getting what you need. Maybe you think there is no value to the business? Sometimes there may be little value, but the cash flow is supporting the lifestyle of one individual, which could affect maintenance. It might just be an exercise to prove some value and then support a position of limited/no maintenance. Experts can provide a better picture of the valuation, but can also serve as a consultant and help you develop the underlying theory for the negotiations or settlement strategy.

Try to fit the budget with the work needed. Valuations can be developed in stages, so you could hire an expert to (1) review the documents and give you an indication of whether the company is worth valuing, (2) if there is value, then proceed to give you an idea of the value range in order to settle the case or prepare for negotiations and (3) finally, if you get close to trial or deposition, the expert can prepare final conclusions, schedules and/or a report, as well as prepare for testimony.

Let the valuation expert help you define the project. Be clear on what you need and then let them tell you what costs may be incurred. Scoping the project and proceeding in stages can save time and dollars as well as provide you and your client with a defendable position in court.

Melissa Gragg 314-541-8163

What is Fair Market Value? Business Valuation Company St. Louis

What is Fair Market Value? Fair market value as a term has many meanings. As a term in business valuation it has a specific meaning.

Filing for Divorce: CPA or Company Valuation Expert in Divorce Court - St. Louis

If you own a business and are getting divorced you may consider your current CPA to value your business. Here are some questions to ask!

Business Valuation Methods: Income Approach and DCF Model - Company Valuation Expert in St. Louis

One of the approaches business valuation companies will consider when providing a valuation of a company is the "Income Approach".

The income approach considers historical income, future revenues of a company, the earning potential and also capital requirements, or how much will be needed to invest in the building and equipment to support future revenue growth. 

There are a couple of ways to look at the potential income of a company. One business valuation method which falls under the Income approach is the discounted net cash flow or DCF method. This method involves projecting the revenues, cost of goods sold, operating expenses, depreciation, working capital and taxes for five to ten years into the future. 

The next step is to discount this future revenue stream to the present, which most of you will recognize as a present value calculation. The discount rate is derived from several methods such as the build up model or CAPM for example. The business valuation expert will also have to take into consideration whether this is a control or minority interest and make an adjustment with a control premium or a discount for lack of control. These are business valuation terms...which we discuss in more detail in other videos. 

There can also be situations where there are liquidity or marketability issues for stock in closely held businesses. There are discounts for lack of marketability to cover these issues.  As you can see there are many steps to consider when valuing a company from the income approach, but at least now you know enough to be dangerous. 

If you would like more information on business valuations, methods to value a company or how to find reputable business valuation companies in Chicago, New York or St. Louis call us at 314-541-8163 or you can find additional videos on company valuation issues at http://www.YouTube.com/businessvaluationSTL

Missouri Divorce Valuation Expert: The Three Levels of Valuation in a Divorce Proceeding

Many attorneys and business owners want to know about valuation issues regarding divorce in Missouri? 

What happens when you own a company and you file divorce papers? Well the first step is to contact an attorney who you trust to handle your case. 

Then you need to start gathering data, including prior tax returns for at least the past 5 years, financial statements, bank records, buy-sell agreements and operating agreements just to name a few. You will then start discussing the value of the company with your spouse, preferably through your attorney. If you find out that your view of the value is different than your spouse's view of the value -- then you may need a business valuation expert. 

I typically see valuations for divorce have 3 different levels -- the first is calculation phase. This is where the expert reviews all info and determines the value of the business -- which is not a full valuation per se. Just calculations and some financial spreadsheets. 

Then you or your divorce attorney may want to initiate discussions again with your spouse with the valuation expert's analysis. 

Don't be concerned if your spouse also wants to hire an expert, that is normal. Sometime the attorneys and parties want the experts to discuss the valuations and see if they can come together on one number -- this doesn't happen often because divorces are very emotional. 

Then the 2nd level is the report phase. if a settlement cannot be reached and the parties get closer to trial, the experts will then produce reports regarding the calculations. This is to outline the valuation methods used by the expert. These reports are ususally submitted to the court and to both attorneys at the same time -- and prior to the court date. 

The final phase is expert testimony. After the reports are issued, the attorneys may want to questions the experts in deposition. This is treated like testimony in divorce court. This happens relatively close to the trial date. And then the experts will testify in trial. 

One thing to keep in mind -- the experts are truly servants of the court and judge and therefore you should work to find an expert that tells you the truth rather than what you want to hear. If your divorce goes to trial you will want an expert who can support their numbers with data and not just opinions.