What is normalised EBITDA and why do buyers keep asking for it?
The number your business is actually priced on, in plain English. What gets added back, what gets struck out in due diligence, and how to build a real figure.
General information only, not financial, legal or taxation advice. Tony Pope holds Queensland Office of Fair Trading licence 4963575.
The short version
- Normalised earnings is the profit a buyer would make running the business, not the profit your tax return shows.
- Add backs must be documented. Undocumented ones get struck out during due diligence and they take price with them when they go.
- Your own wage gets adjusted to what it would cost to employ someone to do your job, and that adjustment can move the number in either direction.
- A defensible normalisation prepared before you go to market is worth more than an optimistic one prepared during negotiation.
Every buyer, every financier and every broker will ask you for this number, and a lot of owners hand over an accounting profit and wonder why the offers come in low.
Normalised earnings is the profit a buyer would make running your business. It is the number your price is built on, and getting it right is the highest return work you can do before going to market.
Why the accounting profit is the wrong number
Your profit and loss is prepared for tax. It is shaped by decisions that made sense for your circumstances and that a new owner would make differently, or would not face at all.
Maybe you take a modest wage and leave the rest in the business. Maybe you take a large one. Maybe the family car, some travel and a phone run through the business. Maybe you own the shed and charge rent above or below what the market would pay. Maybe last year included a one off legal dispute that will never repeat.
None of that tells a buyer what the business earns. Normalisation strips it out and rebuilds the figure on a basis a buyer can actually use.
EBITDA or SDE, and why the distinction matters
Two bases get used and mixing them up produces badly wrong answers.
EBITDA is earnings before interest, tax, depreciation and amortisation. It suits a business with management in place, where the owner is not doing the daily work and a buyer is acquiring a running operation.
Seller's discretionary earnings adds the owner's own remuneration and benefits back on top. It suits an owner operated business where the buyer is stepping into the role and will pay themselves out of it.
The multiples applied to each are different, because the earnings figures are different. If someone quotes you a multiple, ask which basis it applies to before you do any mental arithmetic. Owners get badly misled here, sometimes by accident.
The adjustment owners get wrong
Your wage goes to market rate. Not what you take, what it would cost to employ someone to do what you do.
This cuts both ways and both directions surprise people.
An owner drawing $60,000 while doing the work of a general manager worth $180,000 has earnings that are overstated by $120,000 once the real cost goes in. That is a large correction and it is better to find it yourself than to have a buyer find it.
An owner drawing $250,000 for a role worth $150,000 has earnings understated by $100,000, and normalising it properly adds real value to the price.
If you do the work of two people, the adjustment needs to reflect two people. That is uncomfortable to look at and it is the honest number.
What survives due diligence and what does not
Survives, with documentation: personal vehicle running costs, private travel, personal phone and insurance, family members on the payroll who are not working in the business, genuine one off legal or consulting spend, related party rent adjusted to market, and clearly identifiable non recurring events.
Does not survive: anything you cannot evidence, anything recurring described as one off, and anything the business actually needs. Deferred maintenance is the classic. So is marketing that was cut to lift the profit, because the buyer knows it has to go back in. So is a wage for work that still has to be done by somebody.
The rule I would apply is simple. If a buyer's accountant asked for the document behind an add back, could you produce it in a minute. If not, leave it out.
Why an aggressive normalisation costs you money
There is a temptation to load every possible add back in and see what sticks. It works against you for two reasons.
The first is arithmetic. An add back that gets struck out in due diligence does not just remove itself. It removes itself multiplied. On a three times multiple, a $40,000 add back that fails takes $120,000 off the price.
The second is trust, and it costs more. Once a buyer finds one add back that will not stand up, they start questioning all of them, and then they start questioning the rest of the information too. Due diligence gets longer, and long due diligence is where deals die. Deals rarely fall over on price. They fall over in the gap between agreement and settlement, while somebody goes looking for something and finds a surprise.
A conservative, fully documented normalisation that a buyer can verify line by line will get you a better result than an optimistic one you have to defend.
What to do
Sit down with your accountant and build it properly across three years, with a document behind every adjustment. Do it before you go to market rather than during a negotiation, because doing it under pressure looks exactly like what it is.
Then get a market appraisal built on that figure. It is free and confidential and commits you to nothing, and it will tell you whether the number you are working from is the one a buyer will accept.
Common questions
What is the difference between EBITDA and SDE?
EBITDA is earnings before interest, tax, depreciation and amortisation, and it is normally used where the business has management in place and the owner is not doing the work. Seller's discretionary earnings adds the owner's own remuneration and benefits back on top, and it is normally used for owner operated businesses where a buyer is stepping into the role. Using the wrong one against the wrong multiple produces a badly wrong number, so always check which basis a figure is quoted on.
What can I legitimately add back?
Costs a new owner would not incur, evidenced. Common examples are personal motor vehicle costs, personal travel and phone, private insurance premiums, family members on the payroll who are not working in the business, genuine one off legal or consulting costs, and above market related party rent. Each one needs a document behind it.
What will a buyer refuse to add back?
Anything without evidence, anything recurring dressed up as one off, and anything the business genuinely needs. Deferred maintenance, marketing that was cut and will have to be restored, and a wage for work that still has to be done by somebody are the ones that get struck out most often.
Keep reading
All notes on selling a business · All seller guides · What is my business worth?
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