Smart Business Magazine, October 2017

50 Smart Business Akron Canton October 2017 Clear expectations Why EBITDA matters in M A Business leaders are used to the scrutiny of audits but that doesnt compare to the fine toothed comb of due diligence before a sale A transaction team has a tighter scope says Ross Vozar managing director of Transaction Advisory Services at BDO USA LLP EBITDA or earnings before interest taxes depreciation and amortization is a typical business metric Generally speaking the value of a company is a multiple of that EBITDA based upon the industry youre in But buyers dont want to pay for a non recurring event and sellers dont want to be penalized for a one time expense There needs to be clear expectations on both sides When these arent identified upfront it can slow down or kill a deal Vozar says There can be hard feelings because one party feels like the other is hiding something To avoid confusion sellers are hiring transaction teams to get a credibly backed and true value on the business before they put the company on the market This sell side quality of earnings provides a clear understanding of sustainable earnings that supports valuation in a M A process Smart Business spoke with Vozar about the difference between reported EBITDA and adjusted EBITDA and how it impacts value How might EBITDA change Lets say a company that manufactures roofing products has an EBITDA of 10 million The industry multiple is six times EBITDA so the business owner expects the business to be worth 60 million The owner settles on a buyer However during due diligence the buyer performs a quality of earnings analysis on that 10 million EBITDA which in part seeks to understand how the company earns that 60 million value who are the customers and what is recurring and non recurring income The year prior several hurricanes hit the southeastern U S This company which sells its roofing products through Home Depot sees sales spike in that region The quality of earning analysis determines 1 million of income isnt sustainable its from a non recurring event when people replaced roofs The EBITDA is adjusted from its reported number and value drops to 54 million The problem is that the seller expected to get 60 million What are other areas that commonly cause EBITDA to be adjusted during a transaction Depending on the size of the business sometimes owner personal expenses are charged to the company Sellers want to identity those because going forward the business will not incur those types of expenses which will increase EBITDA Another item that will be missed in reported EBITDA are professional fees For example a 100000 legal settlement was correctly reported but the accompanying 25000 in professional legal fees could be buried in another line item Both expenses are non recurring and can be taken out An area to watch is self insurance reserves used for workers compensation and health insurance which fluctuate Certain large claims could be justified as non recurring In the case of audited financial statements some expenses and incomes may be below an auditors scope and as such arent adjusted as part of the audit Typically the concept of scope isnt used in a quality of earnings and the threshold of significance is lower When multiples of EBITDA are used a 100000 item for example may impact valuation by 600000 It needs to be correctly recorded and classified Also most income statements have an other income and expense line item that is either a catch all or kept separate to identify the amounts as non operating Other income and expense needs to be scrutinized to understand if these items are in fact non operating or non recurring in nature What else do business owners need to know Hire the right adviser or risk being left in the dark These kinds of transactions arent familiar to many successful business owners They dont understand how reported and adjusted EBITDA differ Instead they rely on key advisers to point them in the right direction and that doesnt always happen Its worth the cost time and effort to hire a transaction professional Northeast Ohio is undergoing the most robust transaction environment of the past 10 years Buyers and sellers both need a clear understanding of a companys financial history in order to consummate a transaction ROSS VOZAR Managing director Transaction Advisory Services BDO USA LLP 216 325 1716 rvozar@ bdo com Insights Accounting is brought to you by BDO USA LLP WEBSITE To learn more about the transaction advisory services that BDO can provide visit www bdo com services business financial advisory transaction advisory INTERVIEWED BY JAYNE GEST INSIGHTS ACCOUNTING