What is EBITDA … and why is it so important?

Features - Business Management

EBITDA is considered the most reliable calculation of earnings and ultimately value, within a company.

January 18, 2013

I presented a topic at the recent PLANET GIC event on exit strategies and gave a bit of a “state of industry” as it relates to our current merger and acquisition environment within the green industry. One of the topics that came up was EBITDA.

Simply put, “EBITDA” is an acronym for Earnings Before Interest Taxes Depreciation and Amortization. It is an accounting term and a calculation that is used in many industries, including the green industry, to help determine the value of a company.

EBITDA is considered the most reliable calculation of earnings and ultimately value, within a company. Retrain yourself to think in terms of EBITDA because it will give you a much better understanding of what your company is worth.

You can calculate your internal EBITDA on your own. It’s a great exercise to undertake, and then sit with your controller, outside accountant or CPA and have them verify it. Or, feel free to contact me and I’ll assist you.

Take your most recent year-end financial statement and start with your profit.

Go into your P&L and add any interest expense back on top of the profit figure. Then grab the really significant number, depreciation, and add that to the profit figure.

Do the same with any amortization figure, but typically most contractors do not have much amortization on their books. Now go grab another really meaningful figure: owner add backs.

Depending on the company and what all you run through your P&L, this can be an eye-opener. Does your wife have a company car? Is your company car a Porsche Cayenne Turbo? Did PLANET Great Escape in the Bahamas become a 2 week trip? Add in any of these extra expenses. The result will be your EBITDA number, which will be used in a formula that will determine (in part) the value of your company to a buyer.

Where does the formula come in? All industries are different but most use a multiple x EBITDA in valuing a company. In today’s economy, a landscape contractor can expect to sell for a multiple of 3 to 6 x EBITA. On occasion, a company can sell for more.

I know of a contractor who sold several years ago for 7.8 x EBITDA. The economy was much better, but the main reason they got that high of a multiple is because they had a solid exit strategy.

Here is what drives the range from 3 to 6 x EBITDA:

Three x EBITDA is a company that is heavy into commercial construction and has less than 50 percent of additional revenue in maintenance. It is also a maintenance company that has issues. The company underperforms in gross margin, doesn’t retain their clients, has fair to poor route density, etc. They It could also be a residential D/B contractor: always subjected to the ways of the economy.

Four x EBITDA is a decent company but they have some things holding them back.

In the example of the commercial installation contractor, maybe most of their work is negotiated as opposed to hard bid but they still are too dependent on installation. The maintenance contractor has good routes, but they have operational issues that hurt margin and results in an 85 percent retention as opposed the desirable 90 percent.

Five x EBITDA is a pretty solid company. It has a good management team and has a pretty good brand in its market. It’s either a maintenance company or a lawn care company with a good track record of selling enhancements.

The equipment has been well maintained and the buyer does not foresee a big capital expenditure in upgrading the equipment and fleet. The company has a 90 percent retention rate, and a solid, verifiable track record of profits.

Six x EBITDA is at the top of the market today. This is a company hitting on all cylinders, with one exception: commercial installation contractors. There is no buyer today paying a 5 or 6 x for installation contractors. This is a company with very solid middle and upper management teams. The majority of the revenue is reoccurring. It has a track record of more than 90 percent retention with clients, and 15-20 percent net profit.

These companies also have tight maintenance routes as evidenced by low fuel expense and overall labor percentage. This is a company that are making a level of profit that they don’t need to sell.

A key aspect of any exit strategy is driving your EBITDA figure up. Manage and operate your company like it is “for sale” right now. Do everything you can to drive earnings and EBITDA up. You will make more money, have a more marketable company, and will have your house in order.