Is EBITDA the best metric to use when calculating business value?
Ian R. Campbell, FCPA, FCA, FCBV is the president of Business Transition Counsel Inc. and the author of 50 Hurdles: Business Transition Simplified.
Ian is one of the most distinguished and recognized business valuators in North America. He has been instrumental in developing the practice of business valuation consulting in Canada through participating in the founding of the Canadian Institute of Chartered Business Valuators, lecturing and writing.Full Bio
Many articles that I read on business valuation talk about earnings before interest, taxes, depreciation and amortization (EBITDA). Is EBITDA the best metric to use when calculating business value?
My answer is almost without exception, "No." That said, I think that the EBITDA business valuation methodology may be, in some cases, an enabler of business value approximations. However, notwithstanding EBITDA has, and seemingly is, being used with some regularity, let me give you my experience over these last 45 years as a brief history of it.
I don't recall anybody making an EBITDA calculation of any kind up until about 1985, maybe 1990. EBITDA became a way for investment bankers to develop what are called fairness opinions, when public companies do transactions and an independent opinion is required for securities and shareholder purposes. I have always thought EBITDA calculations were adopted because in those transactions there is a very serious time limitation on the people giving these fairness opinions between the time they are asked to give the opinion and the time it has to be made public. That time frame is typically so short that very often the due-diligence that an investment banker or anyone giving a valuation opinion might want to do prior to giving the opinion may be somewhat time-limited.
In my view EBITDA became a short-cut way to generate fairness opinions, and it became a principle way of generating them. The problem with EBITDA-based opinions is very simple: they may work reasonably well if you are valuing a service business with little capex requirement. Where a business has a capital requirement and you have to determine the difference between sustaining capital and growth capital, then EBITDA doesn't take that into account and you have to reflect the sustaining capital and growth capital mix in the multiple. EBITDA multiples are almost always based on comparable transactions where only publicly available information is known. Hence, in many cases, there is no assurance that the EBITDA multiples derived from comparable transactions are comparable to much of anything.
To me, EBITDA as a methodology generally should be thought of as a litmus test type of methodology to test value results determined under a more rigorous valuation methodology, for example a discounted cash-flow methodology.