finance
EBITDA
Earnings Before Interest, Tax, Depreciation, and Amortization. The standard profitability metric for valuation.
Definition
EBITDA strips out financing structure (interest), tax structure, and non-cash accounting items (depreciation, amortization) to show the underlying operating cash generation. It is the standard metric for comparing companies and for valuation - business sale multiples are almost always quoted as 'X times EBITDA'. For service businesses with little fixed asset base, EBITDA and operating profit are very close. For capital-intensive businesses (manufacturing, transport), they diverge significantly because of depreciation.
Why EBITDA exists and what it tries to solve
EBITDA was popularized in the 1980s by leveraged buyout firms who needed a way to compare profitability across companies with different capital structures (debt loads), different tax jurisdictions, and different asset bases (depreciation policies). By stripping interest, tax, depreciation, and amortization, EBITDA approximates cash operating profit independent of how the business is financed or where it is incorporated. For a US small business owner considering a sale, EBITDA is the number buyers will anchor on. For internal management, EBITDA is less useful because it ignores real cash needs like CapEx and debt service - which is why Warren Buffett famously dismisses it.
Adjusted EBITDA and owner add-backs
Small US businesses are sold on Adjusted EBITDA, not raw EBITDA. Adjustments include: founder salary above market (a buyer would hire a replacement at lower cost), personal expenses run through the business (car lease, family phone, travel), non-recurring legal or consulting fees, one-time settlements, and 'normalized' working capital. A 500K EBITDA business commonly adds back 50K to 150K of legitimate owner expenses, raising Adjusted EBITDA to 600K to 650K. At a 4x multiple, that adds 400K to 600K of sale value. The catch: every add-back must be defensible with documentation. Sloppy add-backs are the fastest way to torpedo a deal in due diligence.
EBITDA multiples in the US M&A market
Common multiple ranges as of mid-2020s: US main street businesses (under 1M EBITDA) trade at 2 to 4x SDE. Lower middle market (1 to 5M EBITDA) trades at 4 to 7x EBITDA. SaaS with 1M+ ARR and healthy retention trades at 5 to 12x ARR (not EBITDA, since often unprofitable). Service businesses with sticky recurring contracts trade higher than project-based work. Customer concentration above 25 percent from one client cuts multiples by 30 to 50 percent. The single biggest multiple-builder is durable recurring revenue with retention above 90 percent annually.
When EBITDA misleads
Three classic traps. First, capital-intensive businesses (trucking, manufacturing, equipment rental) need real CapEx every year that EBITDA ignores. A trucking company with 2M EBITDA might need 1M of annual truck replacement, making true free cash flow 1M. Second, working capital growth eats cash even when EBITDA is healthy - growing AR and inventory absorbs cash that EBITDA does not reflect. Third, stock-based compensation in tech companies is added back to adjusted EBITDA but is a real cost to existing shareholders through dilution. Always compute free cash flow (EBITDA minus CapEx minus working capital change minus taxes) alongside EBITDA before making capital allocation decisions.
FAQ
What is the difference between EBITDA and SDE?
Seller's Discretionary Earnings (SDE) is used for very small US businesses (under 1M earnings) and equals EBITDA plus owner's salary plus owner perks. It represents the total financial benefit to a single owner-operator. EBITDA assumes the business runs with hired management, so it does not add back owner salary. Use SDE for businesses sold to owner-operators (most main street deals). Use EBITDA for businesses sold to private equity, strategics, or operators who will hire a CEO.
How is EBITDA calculated from a P&L?
Start from net income, add back income tax expense, interest expense (net), depreciation, and amortization. Or start from operating profit (EBIT) and add back depreciation and amortization. Both routes produce the same number. In QuickBooks or Xero, depreciation and amortization usually sit as their own line items under operating expenses, making the calculation straightforward. Avoid pulling EBITDA from non-GAAP reports prepared internally without a clear bridge to GAAP net income.
Why do tech buyers use revenue multiples instead of EBITDA?
Many high-growth US SaaS companies are unprofitable by design - they invest heavily in growth, which produces negative EBITDA but rising ARR. Multiplying negative EBITDA produces nonsense. Revenue multiples (typically 4 to 15x ARR depending on growth and NRR) better capture the value of recurring revenue with high gross margins. As companies mature and approach profitability, the market shifts back to EBITDA multiples around 15 to 25x for healthy SaaS.
Should I use trailing or forward EBITDA for valuation?
US M&A typically uses trailing 12 months (TTM) EBITDA as the verified baseline, with adjustments for one-time items. Sellers will pitch forward EBITDA based on next-year projections; sophisticated buyers heavily discount this. A useful framework: agree on TTM Adjusted EBITDA for the base price, then add an earn-out tied to actual forward EBITDA performance. This aligns incentives and protects buyers from inflated forecasts.
Does EBITDA include rent?
Yes, rent is a regular operating expense and reduces EBITDA. Under US GAAP after ASC 842, operating lease expense (rent) still hits the income statement above EBITDA. The exception is finance leases, where part of the payment is interest expense (added back) and part is depreciation (added back) - which can shift reported EBITDA. Buyers normalize for lease accounting differences during due diligence; sellers should pre-empt this by presenting both reported and normalized EBITDA.
In your business
- →Use EBITDA when valuing or selling the business
- →Use operating profit when running the business day-to-day
- →Owner add-backs (your salary, personal expenses run through the business) are recalculated for 'adjusted EBITDA' in a sale