Knowing this will be key if selling in the next few years
For those owners considering their exit strategy options, having strong Earnings Before Interest Taxes Depreciation & Amortization (EBITDA) is of course an essential element in order to command a premium valuation from outside parties. There are some exceptions to this such as high technology companies, where profit may be less of a driver in the valuation of a company, but for most businesses EBITDA is essential. Thanks to Zachary Scott & Co, they're now bringing much needed attention to EBITDAC, adding COVID adjustments to the equation.
In a normal exit event for a business, adjustments to profitability are taken into consideration. These adjustments fall into the following categories:
- GAAP Adjustments – these adjustments relate to how you may currently be reporting various areas of your financial statements versus what the GAAP (Generally Accepted Accounting Principles) requirements call for. Ask yourself, are my financials to GAAP? If not, discuss this with your accountant to understand how your financials may look different if they were to GAAP.
- Owner Adjustments – these adjustments relate to costs to the business directly related to monies that ownership may be taking out of the business that a future owner may not incur. Things like cars for family members, perhaps a boat, travel, etc, that the current owner may incur but a future owner most likely will not.
- One Time Adjustments – these adjustments relate to costs your business incurs in a given period but will unlikely ever repeat. These could be one-time legal expenses, one-time warranty expenses that were unusual, employee training that is not being repeated, etc. Work with your accounting partner to ensure these types of costs are regularly being captured for future reporting of your adjusted profitability.
- COVID Adjustments – these adjustments relate to two possible areas. The first is what costs did your business incur through this pandemic that are one-offs (or at least until another pandemic hits). Costs related to extra cleanings of your facility, buying cleaning supplies, gloves, hand sanitizers, etc that you normally wouldn’t incur had there not been the pandemic. These costs reduced your profitability and should be reflected in your adjusted profitability.
The other COVID related adjustment is a more difficult one to capture and represent and that is any negative revenue impact your business experienced due to COVID. One could argue that had the pandemic not hit your business, your revenue would have been higher and so too would your profit have been. Some business owners project their adjusted profitability through COVID trying to reflect this impact but of course it’s much more difficult to get an investor or acquirer to embrace this. They can certainly see the facts behind the COVID costs related to cleaning and supplies but less so related to the revenue you believe you lost.
Bottom line is this, if you’re hoping to implement an exit strategy for your business in the next 5 years, being able to represent your adjusted EBITDACA will be essential as those placing a valuation on your business will want to look back at least 3 years and potentially back 5 years which means 2020/2021 will be part of their analysis. As part of presenting your adjusted profitability, be fair to yourself and make sure you are including an effective monitoring and tracking of your annual profit adjustments which now includes the COVID impact.
