EBITDA and director salaries

[Hogmahub]

I'm looking at buying a business where the business transfer agent has added back director salaries into profits, inflating the EBITDA.

As both exiting directors work full time in the business, is this legitimate? I'd think not but the transfer agent is saying that its valid.

Thanks

Ian

 

[telephoneman]

It's the agent's job to make the business look as attractive as possible and as these are presumably not the statutory accounts then the term "legitimate" doesn't really apply.

If the acquiring party isn't going to need something or someone (or that's the agent's assumption) then they will remove the costs to illustrate the potential profit to a buyer.

If however the directors are doing a real job of work and will need replacing by someone else at similar (or maybe even higher?) cost then you need to point this out to them as a reason why the deal isn't as great as they are trying to make out.

Liam

 

[Hogmahub]

Thanks.

So just to be absolutely clear....

The directors jobs will need to be filled to ensure the continued running of the business. As such when I make an offer, based on multiples of EBITDA, it will be seen as correct and reasonable not to add back the director salaries?

I don't want to alienate the vendor as they will be needed for a handover period.

Ian

 

[Tom McClelland]

I suppose the question might be, do the director's jobs need filling at equivalent cost, lesser cost, or greater cost? The answer to that question determines what EBITDA adjustment would be appropriate when assessing the business profits.

AIH I have an instinctive dislike of EBITDA. Too often it seems to be used to inflate profit by adding back all sorts of genuine nasty costs that we'd prefer to forget about in a perfect world. Those costs may well not magically disappear just because a new buyer owns the business.

 

[alpha7158]

I suppose the question might be, do the director's jobs need filling at equivalent cost, lesser cost, or greater cost? The answer to that question determines what EBITDA adjustment would be appropriate when assessing the business profits.

AIH I have an instinctive dislike of EBITDA. Too often it seems to be used to inflate profit by adding back all sorts of genuine nasty costs that we'd prefer to forget about in a perfect world. Those costs may well not magically disappear just because a new buyer owns the business.

Yes EBITDA is horrendous for measuring performance.

In the words of Warren Buffet: "References to Ebitda make us shudder.

 

[Strontium Dog]

If you are going to use this method, the correct approach is to add back the directors remuneration, but DEDUCT from profits the market rate for employing someone to fill the role.

Also make sure you focus on as up to date figures as you can, subsequent to the last set of financial statements if the info is available. I would try and construct a set of fiinancial projections for the business, and base your EBITDA calcs on those, as the value of the business is based on future, not past, performance.

If you are buying the company as a bolt on to an existing business you should really include the existing business in your calcs to establish how much the business is worth to you. You might be pleasantly surprised if there are synergies between the two.

I'm surprised the business transfer agent is mentioning valuation techniques at all, most of the ones I have come accross just seem to think of a number !