A single adjustment to your financials could increase the value of your business by hundreds of thousands or even millions of dollars. Yet many business owners don’t realize it until they begin talking with buyers.
Most buyers don’t value your company based on net income. Instead, they focus on Adjusted EBITDA, the number that reflects the true earning power of your business. So, what is Adjusted EBITDA and how do you calculate it?
Start With EBITDA
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Think of it as a way to measure how profitable your business is before financing decisions, tax strategies, and accounting rules come into play.
Buyers ignore interest because they may finance the business differently. They ignore taxes because those depend on ownership structure. Depreciation and amortization are accounting entries rather than current cash expenses. The result is a cleaner picture of operating performance.
Why ‘Adjusted’ EBITDA Matters
Privately held businesses often include expenses that reflect the owner’s situation rather than the ongoing economics of the business. Buyers want to know what the company would earn under normal ownership and that requires adjustments.
Most adjustments are add-backs that increase EBITDA: owner compensation above what a professional manager would earn, personal expenses run through the business, one-time legal costs, above-market rent paid to a related entity, and family member compensation above fair market value for the role.
Adjustments can also go in the other direction. If an owner draws little or no salary but is actively running the business, a buyer will typically deduct a market-rate management salary from EBITDA. This is simply the opposite of an owner compensation add-back.
Every adjustment needs to be defensible. If you can’t explain and document it, don’t expect a buyer to accept it.
A Worked Example
Below is a sample Adjusted EBITDA walkthrough for a hypothetical services business with $5 million in annual revenue. The figures are illustrative, but the structure mirrors what buyers and their advisors typically prepare when evaluating a business.
|
Item
|
Amount
|
Notes
|
|
Starting Point: As Reported
|
|
Net Income
|
$420,000
|
From tax return or P&L
|
|
+ Interest Expense
|
$55,000
|
On any debt obligations
|
|
+ Taxes
|
$140,000
|
Federal + state income taxes
|
|
+ Depreciation & Amortization
|
$85,000
|
Non-cash charges
|
|
= EBITDA
|
$700,000
|
Before adjustments
|
|
Add-Backs: Owner / Non-Recurring Items
|
|
+ Owner Salary Above Market Rate
|
$125,000
|
Owner paid $275K; market rate ~$150K
|
|
+ Personal Vehicle (Owner)
|
$18,000
|
Personal expense run through business
|
|
+ One-Time Legal Settlement
|
$40,000
|
Non-recurring; won't repeat under new owner
|
|
+ Family Member Salary (Above Role)
|
$35,000
|
Relative paid above fair market rate for role
|
|
+ Rent Above Market (Related Party)
|
$24,000
|
Building owned by owner's entity; above market
|
|
Deductions: Costs a Buyer Will Actually Incur
|
|
– Additional Management Compensation
|
($75,000)
|
Buyer expects to hire a general manager as owner currently performs strategic oversight without dedicated day-to-day management.
|
|
= Adjusted EBITDA
|
$867,000
|
The number buyers use to value your business
|
Why This Matters
The business reports $700,000 in EBITDA, but several expenses reflect the owner’s personal decisions rather than the ongoing economics of the business. After adding back $242,000 in owner-related and non-recurring items and deducting $75,000 for a general manager the buyer will need to hire, Adjusted EBITDA comes to $867,000. At a 5× EBITDA multiple, that translates into approximately $840,000 of additional enterprise value. The business didn't become more profitable; the financial presentation simply reflected its true earning power more accurately.
|
EBITDA: $700,000 × 5× multiple
|
$3.50 million
|
|
Adjusted EBITDA: $867,000 × 5× multiple
|
$4.34 million
|
|
Difference in enterprise value
|
+$840,000
|
What Buyers Will Challenge
Buyers and their advisors will carefully review every adjustment. They'll ask whether an expense is truly non-recurring, whether owner compensation has been normalized appropriately, and whether related-party transactions reflect market terms. Preparing this information before going to market can make the diligence process smoother and help support your valuation.
The Bottom Line
Adjusted EBITDA is the language of business transactions. Understanding it doesn’t just make you a more informed seller, it can materially affect what your business is worth.
If you’re considering selling, start preparing now. Identify owner-specific expenses, document unusual costs as they occur, and make sure your financials tell the right story before a buyer starts asking questions. The earlier you begin preparing, the more control you'll have over the sale process and the stronger your position will be when it's time to negotiate.
