Here is a question for corporate finance executives seeking either growth capital or ownership transition: Do you know your EBITDA number?
It’s the first question I ask a company’s CFO or treasurer after understanding his/her financing objectives. EBITDA is the accounting abbreviation for Earning Before Interest, Taxes, Depreciation, and Amortization. It’s calculated from income statement items just as the name dictates.
Why is EBITDA so important in today’s market? It’s the standard benchmark that’s used in a variety of important calculations. EBITDA can help you determine:
- How much leverage (debt) for which you could be eligible. In addition to considering how much interest and principal your business can support, lenders also look at a multiple of EBITDA to determine eligibility. In today’s market, that multiple could run from two times (senior debt) to four times (senior plus subordinated debt). Further, if your business has just crossed that threshold from negative to positive EBITDA, you may be eligible to refinance any debt currently on your balance sheet to a new capital structure with lower price and better terms.
- What your business is worth, if you’re considering selling. The enterprise value of your business depends on a multitude of things, but the first metric considered is often a multiple of EBITDA. Depending on your industry, revenues, margins, and growth history, your business could be worth between two to eight times EBITDA.
- The size of the universe of investors willing to provide growth capital to your company. Whether you’re interested in raising debt or equity, investors decide whether to consider your capital needs based on a variety of factors. In our experience, the most important factor is the amount of EBITDA your company has generated in the past 12 months. If that amount is less than $1 million, your banker will find only a few investors willing to consider your request. Between $2 and $3 million, that universe increases substantially. Above $5 million, you’ll have investors chasing your business.
Once you know what your EBITDA is today, you need to consider where it is headed. While your future EBITDA isn’t as important to investors as your metric today, they’ll be interested in your outlook and will consider that in answering any of the questions above. More importantly, it will allow you to plan for that future sale or capital raise. Preparation is key to a successful financing. Plus, forecasted EBITDA can also help business owners develop a strategy for further growth.