VALUATION AND FINANCING OF YOUR COMPANY: THE (IN)SIGNIFICANCE OF EBITDA

Imagine you want to know the potential proceeds from selling your company, or how much financing your company can obtain. You approach an advisor for this purpose. If their first question is, “What is your company’s EBITDA?” I would suggest reconsidering further collaboration with this advisor.

First and foremost, let’s not make the world more complicated than it is. Valuing and financing a company is not an exact science. It involves expectations and assumptions for the future, which are inherently subjective. Ask 10 advisors, and you’ll likely get 10 (possibly very) different outcomes.

At the core of valuation and financing are two aspects:

  1. The business: the risks in your company and the developments in the industry/value chain.
  2. The numbers: the future cash flow from your business.

First, the business…

To understand the numbers well, we must first comprehend the business operations and the industry. Some questions to consider are:

  • What are the implications if your largest customer or supplier disappears?
  • What are the trends affecting your industry, and how are you adapting to them?
  • How easy is it for a startup to become your competitor?
  • What are the consequences if you unexpectedly leave the company?

Followed by other pertinent questions. Ensure you have clear answers to these.

…then the numbers

After conducting a thorough business analysis, it is essential to scrutinize the numbers. It is crucial to realize that EBITDA* is merely a measure of profitability. EBITDA is not cash flow. EBITDA can be manipulated in accounting, but cash flow cannot. Taxes, investments, and changes in working capital are excluded from EBITDA but often have a significant impact on cash flow, making them relevant for the valuation and financing of your company.

Advice: Create multiple scenarios in your cash flow forecasts, including a base scenario, an upside scenario, and a downside scenario. Be realistic with normalizations. Clearly indicate the assumptions for each scenario. This approach often leads to more business-oriented negotiations with less emotional involvement (do not underestimate the value of this…).

Evaluate your homework

What, then, is the purpose of EBITDA? Use rules of thumb to validate your homework against reality. In practice, the enterprise value of small and medium-sized enterprises (SMEs) typically ranges between 3-6 times EBITDA, depending on the industry. The maximum financing for an SME usually ranges between 2-4 times EBITDA, depending on the industry and whether the business premises are leased. If your calculations or those of your advisor deviate significantly from these ranges, it’s worth taking a critical look at them.

*EBITDA = Earnings before interest, tax, depreciation & amortization (operating profit before interest, taxes, and depreciation).

More blog items

Unlocking the Value: Decoding the Income-Based Approach to Intellectual Property Valuation

Het bepalen van de economische waarde van intellectueel eigendom (IE) is niet eenvoudig. Onder de verschillende waarderingsmethoden staat de op inkomstenbenadering centraal.

Navigating the Maze: Unraveling the Economic Value of Intellectual Property

Intellectual property (IP) is a valuable asset that drives innovation, fosters creativity, and fuels economic growth. However, quantifying its economic value can be a daunting task.

THE IMPORTANCE OF STRONG MANAGEMENT

After a presentation by an investment company, one of the attendees asked what the three most important criteria are for investing in a company.

Would you like to know more about our opportunities? We’d love to hear how we can be of service

Call us at  +31 (20) 210 36 35 or reach out to us by leaving a message in our  contact form