Important tip for Buyers of businesses
One important thing for Buyers looking to purchase a business is for them to recalculate EBITDA and SDE if there are multiple owners of the business. It is easy for a Seller or Seller’s advisor to overlook the true SDE and EBITDA when there are multiple owners of a business.
For example, see the Line 12 number of $38,957 below for Compensation of Officers for a tax return.
It seems like SDE and EBITDA would be easy to calculate, just add back the $38,957 for SDE and EBITDA would remain unchanged. If there is only one Seller that calculation would be correct, but what if there are multiple Sellers? How does that change EBITDA and SDE? Does it changes SDE and EBITDA?
The Buyer would need to replace one of the Sellers. This cost to replace the Seller would not be added back to arrive at EBITDA, it would be subtracted. Both EBITDA and SDE would be reduced. The reason for this is the Buyer would incur the cost of replacing one of the Sellers. Here is one other thing to consider: is the current wage of the Seller who is going to be replaced more or less than the is receiving less than the cost to replace them? Whatever that cost is going to be, that is the amount of expense that would be included in the calculation of SDE and EBITDA.
For example, let’s assume the cost to replace one of the owners is $25,000. See the correct calculations below:
Erroneous Calculation Correct Calculation with Multiple Sellers
Net Income $X,XXX,XXX $X,XXX,XXX
Interest XX,XXX XX,XXX
Inc Taxes XX,XXX XX,XXX
Deprec XX,XXX XX,XXX
Amort XX,XXX XX,XXX
Cost to replace
Owner XX,XXX (25,000)
EBITDA XX,XXX XX,XXX
Owner Wages $38,957 $38,957
Cost to Replace
Owner XX,XXX XX,XXX
SDE/Cash Flow $XXX,XXX $XXX,XXX
The result of the above is that EBITDA and Cash Flow are reduced by $25,000. We used $25,000 as a basis for the example, but the number could far greater impact on the business because, let’s assume a 3x multiple of SDE as a basis for value, then the value of the business would actually be $75,000 less due to the correct calculation.
This is a critical part of an acquisition: Buyers beware!