Preamble: Excuse me for the length of this, frankly with my attention span I probably would not go any further either...but I think it will be worth it...and please do not skip to the end...so...
Accounting, jargon, acronyms; EBITDA falls into all those categories and categorically is the most important part of the deal. So entrepreneurs and would be entrepreneurs beware, this is the deal.
EBITDA definition thereof: “Earnings Before Interest, Taxes, Depreciation and Amortization.” Fundamentally correct, easy to calculate, boring, misunderstood and incorrect at the same time.
Here is how you do it: You take the net income and you subtract line items; interest, taxes depreciation and amortization. Yes very similar to the above, but there are several twists, turns, and nuances, almost like a CSI plot.
First what really is EBITDA? It is cash, nothing more nothing less. From a buyers perspective they don’t care about: Your Interest, as it has nothing to do with their capitalization which will be completely different. Your Taxes, they probably don’t expect to pay taxes because they will step up the assets and most likely have a higher debt (ala Interest) load. And your Depreciation/Amortization because these are non cash items which will be stepped up anyway (as mentioned under taxes), allowing them to write off your old junk like it is almost new again, and possibly more than you paid for the stuff. Don’t blame me that is the way the world works.
EBITDA is really “Cash before DAIT” a term I learned a long time ago. It is the cash to play with. The buyer only cares about is how much cash is left and what they can do with the cash.
There are three types of EBITDA, but how can this be? After all we are talking about accounting stuff (GAP stuff) and even worse the IRS could get involved.
Type 1 EBITDA – Accounting EBITDA - Take your QuickBooks (better yet tax statement for 2006) punch the EBITDA button, or do it long hand using the standard definition above. If you own your own business you want really bad (as in low) EBITDA.
Type 2 EBITDA – Sellers adjusted EBITDA. This is where I as a broker or you improve your EBITDA. For example; the owner of the company pays him/her a $150k salary but can be replaced on the open market for $80k, EBITDA just increased $70k. Owner has a Mercedes, key man life insurance; equipment is expensed rather than capitalized (often the biggest adjustment) and of course travel expense to extended conferences such as HostingCon in Orlando and ISPCON near San Francisco. There are dozens of items that can increase your EBITDA. If it is done correctly the buyer has no reason not to accept this calculation.The owner of a private company is expected to operate in its best interest. Pay as little in taxes as legally allowed. Your sorry EBITDA is really good now.
Type 3 EBITDA – Buyers adjusted EBITDA. This is #1, adjusted by items in #2. Now if you do not show the Buyer #2, don't worry, the buyer they will calculate if for you, oops they forgot to tell you. Every one is expected to work in there best interests. What does the buyer adjust? Things like closing the office, relocating your servers to that empty space in their data center, purchase bandwidth at a lower cost and associated items. They might not even need that $80k person expense in #2. This is the ultimate EBITDA.
What does the buyer do with EBITDA #3? Take it to their banker. Who will tell the buyer how much money they can borrow.
And finally I am speaking at ISPCON (Near San Francisco), the M&A series, Tuesday October 16, 9:00 AM, “Positioning Your Internet Company for Sale - and Making More Money”
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