Making EBITDAC work for you

Currently, EBITDAC is going to be a key part of discussions with lenders around banking covenants.

In general terms, growing EBITDA grows the value of your business, and M&A advisers usually adjust EBITDA to get to the underlying position. That means adding/subtracting one-off unusual items.

In normal times these might include specific costs relating to the owner manager, relocation costs, one-off consultancy costs, capitalisation of R&D, or perhaps the costs of discontinued activities.

The COVID adjustments

The impact of COVID could be a big add back for most companies when looking at 2020 results. But if you’re going to drive a transaction off EBITDAC, it’s important that you can justify the “C” adjustment.

You must track the impact of COVID on the business and especially cash flow effects. And not just the obvious cash hits, but ongoing additional costs and the lost opportunities as well.

Adjustments need to look convincing to a buyer, funder or lender. The sort of adjustments they’re likely to find convincing might include:

• Lost or deferred income
• Selling price reductions or cost price increases
• Break costs on leases
• Additional supply chain costs, and associated production delays
• Extra cleaning costs to make premises COVID secure
• Extra ICT costs and training costs to support employees working from home
• Costs of raising additional finance
• Redundancy costs
• Inefficiencies due to having to run the business in a socially distanced way
• Additional professional advisory fees

Keeping score

It’s important to keep score, and to measure all these impacts on the business. They’ll be more difficult to isolate and justify if the record has to be constructed later. Consider additional pages in your board pack or management accounts to track the impact of COVID.

Beyond 2020

The impact of the twin disruptions of COVID and Brexit will linger beyond 2020 and that needs to be tracked too. If you’re looking at business valuation now or considering a transaction in 2021 then forecasts are very important.

Here are some things to consider when testing your forecasts for 2021 and beyond:

• Production of multiple scenarios to stress test assumptions
• Are there any leading indicators in your industry or KPIs in your business that can help understand how the business will perform?
• What does the order intake pattern look like, and do you expect it to recover to “normal” patterns?
• Will COVID have any long-term impact on your industry and its business models?
• As ever cash is key – will there be any ongoing changes to the working capital dynamics of  your business?

What would Warren Buffet say? Or why you should be honest about your EBITDAC

Legendary US investor Warren Buffett said “Beware of geeks bearing formulas” and his business partner and Vice Chairman of Berkshire Hathaway is quoted as saying  “I think that, every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

They don’t like EBITDA as it gives scope to manipulate the underlying performance and issues facing a business. For example, Buffett is also credited as having said “Does management think the tooth fairy pays for capital expenditures?” That last point is fair and for a capital-intensive business you’d expect to factor in a further adjustment to an EBITDA-based valuation.

The moral of the story is that EBITDAC is genuinely useful, but that you must be honest and realistic in how you calculate it. It should present the underlying qualities of the business but it’s no use if it’s not believable!