Quick Answer
EBITDA is an important part of business valuation, but it doesn’t tell the whole story.
Two companies with the same EBITDA can have very different values depending on how dependable those earnings are, how easily they transfer to a new owner, how much risk and reinvestment come with them, and where the business can go from here.
EBITDA tells a buyer how much the business earns. The rest of the business helps determine how much confidence they place in those earnings.
In This Article
- EBITDA Doesn’t Tell The Whole Story
- Start With EBITDA, But Don’t Stop There
- How Dependable Are the Earnings?
- Will Those Earnings Transfer to a New Owner?
- How Much Risk Comes With the Earnings?
- How Much Does It Cost to Keep Producing Those Earnings?
- Where Can the Earnings Go From Here?
- Improving EBITDA Can Sometimes Hurt the Business
- Business Value Has More Than One Lever
EBITDA Doesn’t Tell The Whole Story
Imagine two companies that each generate $1 million in EBITDA. The first has diversified customers, consistent revenue, capable management, documented systems, and relatively modest capital requirements. The second depends heavily on its owner, gets a large portion of revenue from one customer, requires significant ongoing investment, and has earnings that move considerably from year to year.
Same EBITDA, very different businesses.
A buyer isn’t acquiring a number on an income statement. They’re acquiring the company responsible for producing it, which is why EBITDA matters, but it isn’t everything.
Start With EBITDA, But Don’t Stop There
EBITDA, or earnings before interest, taxes, depreciation, and amortization, gives buyers and advisors a useful way to look at the operating performance of a business. Earnings absolutely matter, and if you’re preparing a company for sale, improving profitability can strengthen your position.
The mistake is treating EBITDA as though it answers the valuation question by itself. A buyer still has to ask: How much confidence should I have that these earnings will continue after I own the company?
That’s where the rest of the business starts to matter.
How Dependable Are the Earnings?
A company that consistently produces strong earnings tells a different story than one coming off a single exceptional year. Where does the revenue come from? How much is repeat business? Are margins relatively stable? Was there an unusually large project this year? How much business has to be won again next year?
Customer concentration matters for the same reason. If one customer represents 40% of revenue, today’s EBITDA may be perfectly real; the concern is what happens to tomorrow’s EBITDA if that customer leaves.
The number matters, but so does how reliably the company can produce it again.
Will Those Earnings Transfer to a New Owner?
A company can produce excellent earnings while still depending heavily on its owner. Maybe the owner generates most of the sales, holds the key customer relationships, approves every major decision, or carries technical knowledge nobody else has. None of that necessarily shows up in EBITDA, but a buyer will notice it anyway.
This is why management depth, documented systems, established processes, and customer relationships beyond the owner can matter so much. The issue isn’t whether the owner contributes to the company. Most successful owners do. It’s whether the business can eventually produce those earnings without them.
How Much Risk Comes With the Earnings?
Every business has risk. One company may depend heavily on a major customer, while another may rely on a difficult-to-replace supplier, a few key employees, an expiring contract, aging technology, or a competitive advantage that’s becoming easier to copy.
A business doesn’t have to eliminate every risk before it can sell, but a buyer will want to understand what they’re taking on. The income statement shows what the business has earned; it doesn’t always show how much uncertainty comes with those earnings.
How Much Does It Cost to Keep Producing Those Earnings?
Two companies can produce similar EBITDA while requiring very different amounts of cash to keep running. One may need relatively little ongoing investment, while another requires regular equipment replacement, substantial inventory, facility upgrades, or significant working capital.
It’s also why putting off necessary expenses before a sale can backfire. Deferring equipment replacement or maintenance may make current results look better, but the buyer may still inherit the expense shortly after closing. Improving today’s number doesn’t make tomorrow’s bill disappear.
Where Can the Earnings Go From Here?
Historical performance tells a buyer where the company has been, but they also want to understand where it can realistically go. There may be unused capacity, room for geographic expansion, additional services customers are already asking for, or a sales operation capable of supporting further growth.
But “growth potential” is easy to claim. Almost any seller can say a new owner could expand into another market, hire more salespeople, or launch another product. It’s much more meaningful when the company can point to actual demand, available capacity, or an existing foundation for growth.
There’s a big difference between saying someone could grow the business and showing them how.
Improving EBITDA Can Sometimes Hurt the Business
Owners preparing for a sale are often told to improve EBITDA, and that’s generally good advice. The problem comes when improving the number becomes more important than strengthening the company.
Eliminate a capable manager and take their responsibilities back yourself, and payroll may decrease along with an improvement in EBITDA, but the company now depends more heavily on you. Put off necessary maintenance and current expenses may fall, but the future owner inherits the problem. Cut sales and marketing too deeply and today’s profitability may improve at the expense of tomorrow’s pipeline.
Don’t improve the number by weakening the business producing the number.
If a sale is still several years away, the goal shouldn’t be making one year’s income statement look as good as possible. It should be building a company a buyer will want to own.
Business Value Has More Than One Lever
An owner preparing for a future sale can broadly work on two things: improving the earnings themselves and improving the quality of the business producing those earnings.
Improving earnings might mean growing revenue, improving margins, eliminating unnecessary expenses, or operating more efficiently. Improving the business around those earnings might mean reducing owner dependence, developing management, diversifying customers, building better systems, making revenue more predictable, or addressing deferred investments and other risks.
Ideally, you’re doing both.
Some of those improvements may not immediately increase EBITDA. Developing management costs money, building better systems takes resources, and reducing customer concentration may take years. But they can leave you with a stronger, more transferable company when it’s time to sell.
Build the Business Behind the Number
If you’re planning to sell in the next few years, increasing EBITDA may absolutely be part of the plan, but it shouldn’t be the entire plan.
Strategic Sellability Plan helps owners look beyond today’s earnings and identify the issues that may strengthen or weaken the business in the eyes of a future buyer, giving you time to work on the things that matter while you can still do something about them.
The goal isn’t simply to build a business that earns more. It’s to build a stronger business around those earnings.
Whether a sale is on the horizon or you are simply looking to improve your business value, give us a call at (833) 609-0388 or contact us online to start the conversation.