THE MULTIPLE OF EBITDA METHOD

This method uses a multiple of "operating cash flow" or EBITDA to establish value. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. Generally we use 3 to 5 years of historical operating results or for a cyclical business, one normal business cycle. The EBITDA is then adjusted for things like excess bonuses and unusual items to come up with a normalized EBITDA. We apply the multiple and then deduct the interest bearing debt to come up with the shareholder value.

The multiple used will reflect the buyers assessment of risk – the lower the multiple the higher the perceived risk and vice versa. Other factors affecting the multiple are revenue stability, customer barriers to exit (like contracts), proprietary products or services, market conditions etc.

The advantage of this method is that it is simple and easy to understand. The disadvantage is that it ignores required capital expenditures, incremental working capital needs and the impact of future income taxes (these items are basically factored into the multiple).