The All-Important and Usually Hard-Fought Adjustments to EBITDA

The complications in calculating the appropriate EBITDA arise where something abnormal or extraordinary occurred that pushed the EBITDA lower or higher from what it would be under normal circumstances. The following are examples of common extraordinary items affecting EBITDA:

·      Owner Compensation. Under or over market compensation paid to the business owners. In one of our case studies, the owner might pay herself $500,000 annually, where the market rate for an executive like her is $200,000. She will want to add the amount paid over market, or $300,000, to her EBITDA.

·      Extraordinary Expenses. For example, uninsured repairs for damage resulting from a 100-year flood or a complete branding overhaul that would not occur under normal circumstances. The seller will want to reduce their expenses, thereby increasing EBITDA, by those amounts.

·      Owner Expenses. Expenses arguably relating to the owner’s personal life that would not ordinarily be a business expense. Again, seller will want to reduce their expenses, thereby increasing EBITDA, by those amounts.

·      Extraordinary Income. For example, a disaster relief grant or payment of a large old account receivable that had been written off years ago that would not occur under normal circumstances. The buyer will want to reduce EBITDA by those amounts.

EBITDA adjustments usually become fodder for negotiation between you and the buyer. You argue that several expenses were extraordinary and should not be expected by the buyer under ordinary circumstances, and you therefore adjust your EBITDA upward. The buyer argues that such expenses are quite ordinary in nature and therefore is quite happy with the lower, unadjusted EBITDA.

In calculating a normalized, or adjusted, EBITDA as a seller, we recommend calculating a worst-case scenario (i.e., no expense reductions and all possible revenue deductions), a best-case scenario (all arguable expense reductions and no revenue reductions), and what you expect would be a reasonable negotiated compromise of items in each of the other scenarios. As with all negotiations, your first position will be the best-case scenario, but you will be prepared for that to be adjusted downward through negotiation.

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