EBITDA, earnings before interest, taxes, depreciation, and amortization, is the standard metric buyers use to compare profitability across businesses. It strips out financing decisions, tax structures, and accounting choices to show operating performance. For most sale negotiations, the purchase price is calculated as a multiple of 'adjusted EBITDA,' which adds back owner-specific and non-recurring expenses.
EBITDA is the lingua franca of business sales because it allows apples-to-apples comparison across companies with different capital structures, tax situations, and depreciation schedules. A business with $1M of EBITDA is roughly comparable to another business with $1M of EBITDA, regardless of whether one has heavy debt and the other doesn't, or one has accelerated depreciation and the other uses straight-line.
Adjusted EBITDA is what actually drives the sale price. It starts with reported EBITDA and adds back add-backs, expenses that exist in the seller's books but won't exist for a new buyer. Common add-backs include: above-market owner compensation; spouse or family members on payroll without commensurate work; personal expenses (vehicles, club memberships, travel) run through the company; legal or accounting fees related to the sale itself; one-time items (legal settlement, bad debt write-off, restructuring costs); and rent or other related-party transactions at above-market rates.
Quality of earnings (QoE) reports prepared by accounting firms are now standard in most lower-middle market transactions. The buyer's QoE provider will scrutinize every add-back and challenge ones they consider aggressive. Sellers who proactively get a sell-side QoE before going to market typically defend their adjusted EBITDA more successfully and avoid late-stage purchase price reductions.
EBITDA has limits. It ignores capital expenditures, which matters enormously for asset-heavy businesses. A trucking company with $2M EBITDA but $1.5M annual capex needed to maintain its fleet is meaningfully different from a software company with $2M EBITDA and $50K capex. Sophisticated buyers look at 'EBITDA minus maintenance capex' or 'adjusted free cash flow' to get a truer picture of cash-generating capacity.
Key facts
- EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
- Adjusted EBITDA adds back owner-specific and non-recurring expenses
- Common add-backs: owner above-market comp, personal expenses, family payroll, one-time items, sale-related fees
- Quality of Earnings (QoE) reports are standard in deals over $5M and increasingly common below
- Sell-side QoE: prepared by seller's accounting firm before going to market, defends adjusted EBITDA proactively
- EBITDA minus maintenance capex is a more accurate cash flow measure for asset-heavy businesses
How far back will buyers look at EBITDA?
Most buyers want to see the trailing 3 years of EBITDA, with particular focus on the trailing 12 months (TTM). Trailing 5 years may be requested for cyclical businesses or where there's been significant recent change. Buyers typically use TTM EBITDA as the basis for the purchase price, but adjust if the most recent year is anomalously high or low. A consistent or growing EBITDA trend supports the high end of the valuation range; a declining trend creates downward pressure regardless of the absolute number.
What if my EBITDA spiked in the year before sale, will buyers believe it?
They'll be skeptical, especially if the spike isn't supported by a corresponding revenue or margin story. Buyers and their QoE providers will examine the source of the spike: is it a one-time large project that won't repeat? Is it pricing increases that customers may not accept long-term? Is it cost cuts that reduced quality or service in ways that will hurt future revenue? If the spike is genuine and sustainable, document it carefully and be prepared to defend it. If it's not sustainable, consider whether to sell on TTM EBITDA (the spike) or on a normalized 3-year average, the right answer depends on the deal dynamics.
