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The Practice Buyer's Corner - Random Musings from the Buy-Side
The Practice Buyer's Corner - Random Musings from the Buy-Side
The purpose of this blog is to share current, real world, experiences on the topics of practice valuation, practice transition, retirement planning, and building equity value - over time - in your dental practice.
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seanepp
seanepp

Demystifying "EBITDA"

5/8/2019 8:08:14 AM   |   Comments: 0   |   Views: 453
Good morning fellow Townies!

Just got back from the AAO event in Los Angeles and met with many fantastic practice owners and transition advisors.  Great event!

A recurring topic of conversation was around the term "EBITDA" and what that represents in the context of a given practice's financial profile and potential valuation.

EBITDA is technically defined as Earnings Before Interest, Taxes, Depreciation and Amortization.  It is a corporate finance term used for decades to demonstrate the cash flow the subject business generates.  This is the cash flow that the business owners and prospective buyers can borrow against to reinvest in or finance the acquisition of the business.  

Without getting overly wonky, an even better measure of cash flow would incorporate capital expenditures - often called "CAPEX".  The true measure of any business' value generation is its Free Cash Flow ("FCF") which is defined as EBITDA minus CAPEX.  This represents available cash flow after making the appropriate ongoing reinvestment in the business to protect its value.

I digress!

While an increasing number of transition professionals are incorporating EBITDA analyses in their valuations, most providers and many experts still default to expressing practice value as a multiple or percentage of collections/receipts - e.g. 80%.  This is primarily because of its simplicity, not because lenders and buyers aren't completely focused on understanding the business' cash flow.

Revenue doesn't service debt or fund distributions - EBITDA or FCF do.

So, how do you determine the EBITDA of any privately held business?

        
  1. Make sure you are starting with a sustainable level of revenue or collections - adjusting for any unusual ups or downs
    2.     
  2. Identify all non-recurring or owner-related expenses flowing through the business for tax reasons or otherwise
    3.     
  3. Identify all major expenditures (e.g. individual purchases >$5K) that could have been capitalized but were expensed for tax reasons  
    4.     
  4. Add-back 100% of all other compensation the owners are taking out of the business via salaries, distributions, or otherwise
    5.     
  5. If the related real-estate is owner-occupied, make the appropriate adjustments for above or below market rents
    6.     
  6. Critical:  Now incorporate a fair-market-value salary or compensation package for the provider-owners as associates
The forgoing exercise should generate a figure often referred to as Adjusted EBITDA.  This is the financial metric that most informed buyers use when valuing a practice.  Adjusted EBITDA is the cash flow that a business owner has to sell or convey to the next owner.

So, I'll push pause for now to see if there are any questions or comments.  

Up next:  Discussing "run rate" and "pro forma" concepts in the context of practice valuations - very important to understand in high growth businesses.  
 
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