EBITDA to Value a Business
March 2023
EBITDA (earnings before interest, taxes, depreciation and amortization) is one of the most used measures of cash flow to value businesses. Multiples of EBITDA derived from comparable companies are applied to the subject company to determine a value not including interest-bearing debt, otherwise known as “enterprise value”. EBITDA measures cash flow available to pay taxes and debt and to expense depreciation and amortization.
The advantages of using EBITDA include: 1) it is easy to calculate; 2) it is commonly used and understood; 3) it is widely accepted as a value metric, and; 4) is easily applied to the subject business.
Criticisms of using EBITDA include: 1) it is too simplistic; 2) it doesn’t consider capital expenditures; 3) it doesn’t consider the level of debt; 4) it doesn’t consider the level of taxes; 5) it doesn’t consider the level of net income; and 6) EBITDA doesn’t conform to “GAAP” (Generally Accepted Accounting Procedures). EBITDA also doesn’t specifically take into account the expected growth in cash flow, as is done in a discounted cash flow (“DCF”) valuation that utilizes projected cash flows. Anticipated growth, however, can be considered by adjusting the market multiple of EBITDA used to value the subject business.
A “comparable” business with positive EBITDA could have negative net income, which is not a good thing, or have much higher or lower levels of debt or capital expenditure needs than the subject business. Therefore, EBITDA should only be used when the comparable companies are truly comparable with respect to the things EBITDA doesn’t measure.
All in all, although the use of
EBITDA has its drawbacks, it
continues to be widely used to
value businesses, due mainly
to its ease of use. Its
drawbacks can be mitigated by
the use of other metrics to value
the subject business such as a DCF
or by using market multiples of
other measures of cash flow or
earnings such as net cash flow
or net income.
Relevant Court Cases
-
Cecil v. Commissioner,
United States Tax Court,
Docket Nos. 14639.14, 14640.14,
filed February 28, 2023
-
Estate of Hoensheid v. Commissioner,
United States Tax Court,
Docket No. 18606-19,
filed March 15, 2023
Recent Business Valuation Articles
-
“Corporate Bond Moments and Predictability
of Equity Returns,”
by Sophia Zhengzi Li, Peixuan Yuan, and Guofu Zhou,
dated March 1, 2023
-
“Estimating the Market’s Expected,
Return and Uncertainty From Option Prices,”
by Nikhil Jaisinghani,
dated February 2023
Recent Engagements
- Valuation of the common stock of a manufacturing
and distribution conglomerate for purchase/sale
purposes.
- Valuation of limited partnership interests
in an elemental metal processing facility
on a minority interest basis for planning purposes.
- Valuation of member interests of an investment
holding company on a minority interest basis for
trust administration purposes.
- Valuation of the common stock of a niche chemical
manufacturing company on a 100% controlling
and a minority interest basis for planning purposes.
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