Cashflow

And other broker definitions?

It seems there are no standardized definitions. Each broker just decides what they are, and it is the buyers job to suss out what that actually means. I am still naive but learning quickly. What follows are my current understanding of these definitions and what it means to me as I evaluate businesses.

Cashflow

Cashflow can be defined as everything from seller discretionary earnings (SDE) to gross profit, essentially there really is no set defined definition. This means a reasonable looking price at 3x or 4x cashflow can actually be a completely unreasonable price of 10x SDE, as was the case with a recent deal I was evaluating. The cashflow on that deal was listed as $700K, and they were asking $2.1M. This multiple seems completely reasonable of 3x, but when I received the confidential information memorandum (CIM) the adjusted SDE was ~350K, thus making it nearly 6x multiple. I somewhat hilariously asked the broker if the sellers would entertain offers of around $1M explaining my rationale, needless to say I have not heard back.

Side note: I bought the Bizbuysell Edge Membership to basically be able to see how long it has been listed on the site, and in this case, it was almost one year.

SDE

Seller Discretionary Earnings (SDE) would seem to be a standard definition of essentially the Earning Before Interest, Taxes, Depreciation, and Amortization (EBITDA) plus one owner salary. This, however, is not the case as each broker defines SDE slightly differently. For instance, if there are 2 or more owners, it seems some add back all of their salaries. The way I see this is, if I am willing to do the job of 2 or more people, who have been doing their job for a long time, then sure add both back. This is obviously not realistic, so in my calculations I need to subtract the salary of all but one owner, with the obvious plan of hiring other individuals to do the others job. Further, exacerbating the problem is that the more people that own and operate in the business the harder the transition will be, so likely the evaluation should actually be lower to account for this additional risk.

EBITDA

Earning Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is a standardized definition as described by Investopedia. The difficulty arises as the brokers actually use adjusted EBITDA, annualized EBITDA, and other not standard definitions of EBITDA. This basically fits with everything I am learning that the Mergers & Acquisitions (M&A) space is basically a game of figure out what my words actually mean to win the prize.

Adjusted EBITDA is the brokers attempt to recast the earnings if you were the owner, instead of the current owner. This means they subtract things like personal expenses that were run through the business, depreciation, and other things they believe you don’t need to run the business. Then they add things like adjusting to market rent if the property is owned by the seller.

Sounds simple, but in reality they often add back things that seem essential to the business like cell phones, advertising, etc. They call some of these one-time expenses, but are they really?

Depreciation is the write-off they get for capital equipment to offset the cost of replacing the equipment over its useful like. So, my view is that this is basically the capital expenditure (CAPEX) that needs to be spent to keep the business operating. Sure some things last way beyond their depreciation schedule, but unless I have specific knowledge of that being the case I am going to subtract CAPEX from my own adjusted EBITDA, which I called Jordan’s EBITDA (JEBITDA). FYI, it’s pronounced JEB-I-T-DA, and my wife says my dad jokes are lame.

These add backs can get crazy when the owner uses the business as a piggy bank. One CIM I looked at recently had over 30 add backs for each year. You can find a good deal of information on add backs here in this Big Deal Small Business article.