When sell a business, there are several ways a buyer arrives at a valuation. Two commonly used methods are a DCF analysis or, more simply, a valuation based on a multiple on EBITDA.
In both cases, (EBITDA) normalizations almost always play an important role. But what exactly is meant by that? And why can these normalizations have so much impact on the final purchase price?
What are (EBITDA) normalizations?
When selling a business, people often look at EBITDA: earnings before interest, taxes, depreciation and amortization, or operating profit. This measure shows how profitable a business is before financing structure and investments, and thus gives a picture of its operational performance.
However, the EBITDA coming directly from the financial statements almost always contains costs or income that do not properly reflect the structural profit. Consider:
- incidental costs, such as legal expenses or one-time marketing projects
- private elements or non-business costs
- Management fees that are not in line with the market
- one-time subsidies or revenues
Normalizations correct EBITDA for these types of items, so that both buyer and seller get a realistic picture of the future profitability of the company.
The power of the EBITDA multiple
Buyers base their bids on expected normalized cash flows in the future, which are then translated into a multiple on EBITDA. A simple example:
- EBITDA: € 1,000,000
- Multiple: 5.0
- Enterprise value: €5,000,000
The amount of the multiple depends on the industry, scalability, risks, the investments needed for future growth and any synergy benefits, among other things.
Precisely because a multiple is applied to EBITDA, normalizations can have a big effect. Suppose the seller has included a structurally higher management fee compared to an employment remuneration appropriate to the role performed by the DGA, then a normalization of €50,000 at a multiple of 5.0 leads directly to:
€50,000 × 5.0 = €250,000 additional value.
What, in the seller's eyes, is a justifiable correction causes a €250,000 increase in the purchase price. It is therefore not surprising that normalizations are often the subject of discussion.
How do you avoid discussions and valuation losses?
Good preparation makes all the difference. At least pay attention to the following points:
1. Getting the company ready to sell
By starting early to prepare the company for a sale, allowing some costs to be adjusted in advance. Preventing a normalization is always better than having to substantiate one.
2. Document all corrections
Always substantiate normalizations with invoices, calculations or explanations. During Due Diligence , every detail is looked at. Private expenses, double-booked costs or old agreements then emerge much more clearly than in everyday practice. The more transparent the substantiation, the stronger you are towards the buyer.
A good valuation is not only about numbers, but also about what lies behind the numbers. Carefully worked out and substantiated EBITDA normalizations are essential for a market-based enterprise value. An adviser can estimate early on which corrections are avoidable or market-conform and negotiable. This prevents surprises and valuation losses later in the process.
