Page 9 - NBIZ Magazine February 2024

her company’s EBITDA. Often owners have other priori- held companies either do not track their EBITDA, or their
ties, most commonly minimizing taxes. Many tactics that initially reported EBITDA has not been adjusted to reflect
reduce taxable income also artificially reduce EBITDA. business decisions that may understate or overstate the
Common examples include: figure from the perspective of an outside third-party buyer.
Calculating one's company's adjusted EBITDA in-
0 Above-market compensation: If one’s salary exceeds volves carefully reviewing these issues and preparing a
the amount that he/she could reasonably pay some- true picture of company earnings. Items that artificially
body else to perform your job, the extra above-market understate EBITDA are “added-back” into the figure, and
compensation reduces the company’s earnings, hence items that overstate EBITDA (“negative add-backs”) are
lowering EBITDA. subtracted. The math is not difficult, but it is essential
0 Company-paid expenses: EBITDA is also lowered by that a person at the company has deal experience and
ownership-related perks such as vehicles, expense knows the normal and customary adjustments to take.
accounts, travel reimbursement, and large retirement Buyers typically want to see the prior three to five years’
plans contributions. financial statements, so it is imperative to have adjusted
0 Inflated lease: If one owns an office building and the EBITDA where necessary over that entire period.
leases it to the company at a higher rental rate than Otherwise, any of the following problems can occur:
might be available from another landlord, the extra
rent lowers the company’s taxable earnings and also 0 If one's EBITDA is artificially understated, as is
reduces EBITDA. common, offers from buyers may be lower than
0 Additional payroll costs: Putting family members on otherwise possible. For example, if a buyer offers to
payroll with generous salaries is a common tactic for pay seven times the earnings for your company, then
many privately held companies, but also lowers the every $1.00 that your EBITDA is understated will
company’s EBITDA. cost you as much as $7.00 off your sale price.
0 If one's EBITDA is overstated, this will likely come
A company’s EBITDA is not always understated. Other out during negotiation or the due diligence process,
business decisions can cause EBITDA to be overstated. For throwing a rather large wrench in one's plans to
example, if one is paying yourself a below-market salary, sell the company for a certain price. For example, a
perhaps to free up cash to reinvest into the company or be- buyer paying seven times the earnings may reduce
cause the owner takes the lion’s share of his/her income in its offer price by $7.00 for every $1.00 that EBITDA
the form of profit distributions, then the company’s initial is discovered to be overstated.
EBITDA may be higher than it otherwise would be if he/she 0 Whether under or overstated, if the owner and the
was paying oneself market-rate wages. Many issues can potential buyer cannot agree on what the accurate ad-
impact EBITDA positively or negatively, including account- justed EBITDA is, it will be hard to reach agreement
ing methods, employee benefits programs, and product on the company value and other important figures,
development costs. The bottom line is that many privately undermining one’s chance to sell the business.

NBIZ ■ FEBRUARY 2024 9