Note: This content originally appeared in Carter Morse & Goodrich’s Insights in 60 seconds marketing post, and has been published here with permission.
For those involved in M&A, EBITDA (earnings before interest, taxes, depreciation and amortization) is the often-referenced, industry standard metric that plays a major role in how companies are traditionally valued. For those considering a sale of their business — the rule is that when you maximize EBITDA, you can maximize valuation.
Calculating EBITDA is equal parts science and art. In order to present EBITDA in its best light, it is necessary to adjust EBITDA to account for items considered to be extraordinary, non-recurring and one-time in nature (i.e. moving costs, one-time professional fees, expenses that could have been capitalized, investment and start-up costs), and those non-arms length expenses (i.e. excess compensation, owner related expenses, rent to related parties) that may be adjusted to market rates under new ownership.
These are the proverbial "add-backs" that are used to normalize EBITDA as the basis for valuation. (Read also: Challenging How We Think of EBITDA.)
The impact of the Coronavirus could possibly be the mother of all add-backs.
The Add-Back is Only as Good as Its Justification
For investors and lenders to accept these "add-backs" into their valuation and underwriting methodology, add-backs must be reasonable, well-documented and defensible. We recommend that business owners track the impact that the crisis is having on their business in as much detail as possible.
Tracking should include not only include increased expenses, but also lost opportunities, changes to the business and impact on cash flow. Owners should also delineate between those that are one time in nature and those that will require a continuing effort.
Cast a Wide Net
Below are some practical areas to identify/quantify the impact:
- Lost/deferred revenue, including any temporary price reductions or increases.
- Changes in product purchasing and sourcing (cost increases, freight expediting, etc.)
- Employee/Office safety and cleaning measures (supplies, janitorial service, down time, etc.)
- Employee absence or severance costs, and re-hiring costs.
- Increased compensation or incentives offered for employees.
- Information technology (IT) expenses to accommodate working remotely.
- Increased outside professional service costs (legal, HR, financial).
- Expenses related to termination of leases or other operating contracts.
We recommend that owners cast a wide net to capture as many add-backs and adjustments as possible to arrive at the newest important acronym EBITDAC.
Don't Wait — Start Tracking the Impact Now
While we recognize that owners are struggling with many important issues during these challenging times, it is best to start tracking the impact now. It will be more challenging to capture all these impacts on the business in hindsight, potentially years from now.
Start tracking these today to ensure that more items are captured and there will be adequate support behind each impact, thus creating a more articulate and defensible add-back to EBITDA.