While balance sheet numbers may appear as a true reflection of reality, during a business sale, M&A advisors often “normalize” these figures to present the best financial performance. So, what are they searching for, and what can you do now to streamline the sales process?

This article elucidates 10 crucial adjustments that can optimize your chances of selling your business at the best possible price.

Why Normalize EBITDA?

EBITDA is typically viewed as an operational cash flow indicator.

EBITDA, as an indicator, can be interpreted in various ways.

It’s often used to value companies by applying a multiple. As EBITDA can sway a business valuation, normalizing it to present the best representation is sensible. A discerning buyer will look beyond EBITDA and focus on free cash flow to value a business (considering capital expenditures, interest, taxes, etc.). Valuation is based on an EBITDA calculation, so understanding how to normalize EBITDA and present the highest possible price is a valuable skill for business owners.

TOP 10 EBITDA Adjustments

Here are 10 excellent normalization adjustments for EBITDA (in no particular order). It’s vital to make these calculations before listing your business for sale. Engaging a merger and acquisition consultant should save business owners money during the sales process.

1. Revenues or Expenses:
This adjustment pertains to a company engaging in transactions with related parties at above or below market price. For instance, if your operating company purchases supplies from another company owned by a significant shareholder at prices above market value, you would normalize EBITDA to reflect the fair market value of those supplies.

2. Income or Expenses Generated by Unnecessary Assets:
Unnecessary assets are those not required to operate the business. For example, if your business has a cottage asset supposedly used for business functions or as an employee incentive. Since the cottage isn’t needed to operate the business, expenses related to it paid by the company would be added back to normalize EBITDA.

3. Owners’ Salaries and Bonuses:
Owners’ salaries often deviate from the regular pay scale, frequently due to a bonus declared in the subsequent year if the business is owner-managed, to minimize income taxes. This bonus, and any non-standard owner salaries, must be added back to calculate recurring EBITDA.

4. Leasing of Equipment at Prices Above or Below Fair Market Value:
Many companies lease facilities from a holding company owned by a shareholder. If the rent is arbitrarily set above market value, EBITDA would be adjusted upwards by adding the arbitrary rent and subtracting the true market rent.

5. Start-up Costs:
In the case of a new business line launched during the period under review, associated start-up costs should be added back to EBITDA as they are sunk costs and won’t be incurred in the future.

6. Lawsuits, Arbitrations, Insurance Claim Recoveries, and One-Time Litigation:
Any extraordinary revenues or expenses settled during the review period would not recur, and thus, they would be deducted (in case of income) or added back (in case of an expense).

7. One-Time Business Expenses:
Expenses incurred related to non-recurring matters should be identified. For example, legal fees a company incurs to settle a dispute.

8. Repairs and Maintenance:
Often, private business owners misclassify capital expenditures as repairs to minimize taxes. A proper review that focuses on separating and adding any of these capital items to EBITDA is essential.

9. Inventory:
If your company uses equipment to provide services, it likely has an inventory of spare parts. Often, private business owners maintain a general supply of spare parts throughout the year (for example, 25,000 Euros for a small warehouse) to minimize revenue for tax purposes. If the inventory exceeds the general allowance, it would be prudent to count and value this inventory as close as possible to the time of sale. Any excess over the allowance should be added to EBITDA to reflect the true value of the deferred inventory.

10. Other Income and Expenses:
This category in the financial statement is usually packed with items that can be added to EBITDA. It’s also sometimes a “catch-all” category for expenses that can’t be coded elsewhere. Keep a close eye on these accounts and ensure anything non-recurring is added back in. For example, some companies record one-time employee bonuses or special expenses related to donations in this category. These expenses should definitely be added back to EBITDA.

The process of valuing your business for sale using the EBITDA method isn’t always black and white. Mergers and acquisitions consultants will prepare a record of the last three to five years of normalized EBITDA for the sale of your business. Nothing is stopping you from analyzing your own numbers well before deciding to sell, ensuring you secure the best deal at the right time. In the end, 5x higher EBITDA is undoubtedly more attractive!

In Summary

Valuing a company is a crucial step in the process of selling it. Several methods exist, one of which is applying a multiple to EBITDA, which can be carried out by a mergers & acquisitions expert. We’ve listed 10 possible adjustments that can be applied to EBITDA to achieve a more favorable offer, including income or expenses generated by unnecessary assets, owners’ salaries and bonuses, equipment rentals at prices above or below market value, start-up costs, supplies and recovery of insurance claims and one-time litigations, one-time professional expenses, repairs and maintenance, and inventories. Some operations are entirely legitimate and defensible and can be applied to improve EBITDA upwards.