EBITDA is BS Earnings

“Beware of geeks bearing formulas.” – Warren Buffett

Earnings before interest, taxes, depreciation, and amortization — discussed more commonly using the acronym EBITDA — has become a popular standard by which to measure business performance. Public companies use it on earnings calls to demonstrate achievement. Reporters use it interchangeably with cash flow to describe earning power. Banks look to it as a way to understand the likelihood of debt repayment. If EBITDA has become the gold standard, what’s the problem?

Buffett’s longtime business partner, Charlie Munger, expressed Berkshire Hathaway’s position on this particular formula best: “I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

What Are Buyers Paying for Main Street Businesses?

Main Street” businesses are the large group bridging the gap between small business and the corporate world — earning roughly $2 million to $30 million in revenue and resulting in between $500,000 and $5 million in earnings before interest, taxes, depreciation, and amortization. With such a wide range of numbers, it’s crucial to understand your market position as you prepare to sell your Main Street business.

Why You Shouldn't Sell Your Business To The Highest Bidder

Quick: Would you rather get $14 million for your business when you sell or $10 million? Most entrepreneurs would say $14 million.

That isn’t always the right answer. The higher the offer you get, the more likely it is to include requirements that lower your chances of getting paid in full. And often, higher prices come with tax consequences that can leave you reeling like you got hit on the open field by Clay Matthews. That’s why it doesn’t surprise me that BizBuySell, the online marketplace for small businesses, has found that about half of deals never get to closing after a handshake agreement between buyer and seller.

To get the best deal, you need to dig in the details and find out what getting the higher prices requires on your part. Ask these questions before you accept the top bid. You may be much happier in the end with a deal from the lower bidder.

How to Use EBITDA to Value Your Company

One place to start measuring your company's potential value in a sale is determining your EBITDA, or earnings before interest, taxes, depreciation, and amortization. It's certainly a mouthful, but the equation itself is really quite simple: subtract expenses from revenue (excluding interests and taxes) without depreciation and amortization (what you pay for tangible and intangible assets). The remaining number paints a basic picture of your profitability as well as your ability to pay off what it owes.