Why Use EBITDA Instead of Net Income When Valuing a Business?

When calculating the value of a business most valuations rely on a multiple of EBITDA instead of a multiple of profits. Occasionally, a buyer will object, saying that his return will be after taxes, interest, and depreciation so the profit figure should be used instead of EBITDA. The reason that approach does not work is that the cost of the items that are backed out in EBITDA depend on the sellers circumstances and may be quite different for the buyer.

Let’s look at an example. Assume that we have two businesses (A Widget Inc. and B Widget Maker). Each of the two companies produces the same number of identical widgets, which they sell for the same price, using a machine that cost $2,000,000 and each financed the machine using a bank loan. Because of their credit histories the first company pays 5% on the loan while the second company pays 15%. A Widget Inc. is a sole proprietorship and so shows no corporate taxes on its income statement but B Widget Maker is a C Corp it is paying $100,000 in corporate taxes. Our two widget companies occupy identical buildings, side by side. A Widget Inc. acquired their building a decade ago and this year will be able to take only $100,000 in depreciation. B Widget Maker acquired their building only one year ago and because of the high purchase price will be able to take $400,000 in depreciation on this year’s income statement.

Let’s look at the income statements for these two companies:

……………………………. A Widget Inc……….B Widget Maker

Sales…………………………5,000,000……………..5,000,000
Cost of Goods Sold……..2,000,000……………..2,000,000
Other Expenses*…………1,000,000……………..1,000,000
EBITDA……………………..2,000,000……………..2,000,000
Interest……………………..100,000…………………..300,000
Taxes……………………………….0……………………..100,000
Depreciation…………………100,000…………………400,000
Profits………………………..1,800,000……………..1,200,000

*All other expenses except Interest, Taxes, and Depreciation.

In our simplified universe, based on the excess earnings method of valuation, A would be worth 50% more than B (since 180,00 if 150% of 120,000). But let’s look at what happens to their earnings after you acquire them.

You are going to refinance the machines. Your credit history is better than B’s but you are unwilling to pledge your house as collateral (which A did to get his low rate) so in both cases you could get a rate of 7% (making the interest only payment on the loan $140,000). In both cases you will mark up the value of the building to fair market value, on which you’ll be able to take $450,000 in depreciation. Your company is organized as a C Corporation, and you project taxes on the additional profits at $80,000. Post acquisition, in either case your profits are identical.

So, you ask why not pay on a multiple of what you project your EBITDA would have been? You may internally calculate the rate of return that you’d like to see after non-cash expenses but talking to a seller about your taxes, methods of depreciation, and financing costs is never a good idea. and remember that if you are calculating a multiple based on profits and you want to close deals you’ll need to make the multiple higher since other buyers will be basing theirs on EBITDA.

Finally, I want to add a note about depreciation since with this non-cash expense the problem becomes a little more complex. There is a great deal of latitude in choosing what depreciation method a company uses and often the useful life that is assumed for depreciation is not an accurate reflection of the real world. You certainly do not want to value a company more highly simply because it chose a less aggressive depreciation schedule. In some circumstances, however, depreciation may represent a reasonable approximation of a real expense. I have, for example, seen buyers in the non-emergency medical transportation business who used a seven year depreciation schedule as a proxy for the cost of replacing a fleet of vehicles, which they decided was necessary roughly every seven years. In those cases I have seen buyer and seller agree to talk in terms of EBIT.

Dreaming of Owning an Online Business

Everyone dreams of having his or her own business from the very small to the multimillion versions. Dreams are of course free to anyone. When a dream becomes a reality, there are lessons to be learnt that will help expand or destroy the business.

Depending on a sole supplier for your business widgets could be a fatal mistake if they go out of business and you have not acquired other contacts. The question that you need to ask is whether you would be able to continue with your business if the supplier collapses and how you would tackle the situation.

Businesses grow from interacting with other businesses. Today it is called networking, whether it is done on line or physically over a coffee it is an essential part of the business world. Take time to get to know others and note how they run their business.

If your business is not showing the increase you had planned on, step back, and have the courage to change the current model you have. It is often said that succeeding requires a certain amount of risk, and that risk takers are the ones that succeed.

Your business website may not be all that it should be if the URL you are using is part of the problem. Does it suit your business and have the keyword essential to attracting the customer. A business with no customers will never be a business. The saying ‘fails to plan, and you plan to fail’ is actually a good one. A real business requires a business plan and by default a marketing plan. This puts processes in place to maintain and improve your business, be it an online one or a bricks and mortar establishment.

The much used Strength, Weaknesses, Opportunity, and Threats analysis is a good place to start. When you have a business today marketing becomes extremely important and time needs to be spent everyday nurturing your network, your website, or your customers. There will come a time that the business is on the bones of its backside and all of a sudden, there is no money coming in. It is too late at that point to start realizing the lost opportunities of marketing.

Staying in touch with people on a regular basis creates trust and a well run website can do just that for a firm that takes its customers seriously. We cannot assume that people will stay with a company because the owner thinks they should. ‘Assume ‘makes an ass-of -u-and -me. Trusting people is not without its own risks and others whose perspective is different from our own will have hurt us all. Take the chance, grab your own website and start planning to make your dream a reality.

MLM Home Business Tips – Should You Approach Your Warm Market?

To approach your warm market, or not to approach your warm market – THAT is the MLM home business question!

Before we get to answering the question, let’s look at it from a different perspective…

Suppose you have a full-time, 9-5 job that you’ve been working for the last 5-20 years. It pays the bills (most of them) and gives you somewhat of a sense of security and you’re used to the routine of it all – you’re comfortable… but still you want more…

Then, one day out of nowhere, it comes to you – this INCREDIBLE idea for a new “widget” that will change people’s lives! More importantly, it will change YOUR life with all the money you could make as thousands and thousands of them are purchased every month. Finally you’ll be able to buy your dream home, your dream car, go on exotic vacations, travel, live life according to your desires, not your bosses… This is your shot at success, your ship is about to come in, it’s your turn to cash in!

…So where do you start? You start doing research on the internet, making contacts and networking during your lunch breaks and after work trying to figure out all the details of how you’re going to create and manufacture the actual widget, where you’re going to store them once they’re produced and how you’re going to ship them…

You’ve got it all figured out and now you have the prototype of this incredible new widget that no one has ever come up with before. You’re totally psyched about it and how it’s going to change your life. You’ve spent your life savings and maxed out all your credit cards to design, produce and setup all the systems necessary to get this new widget out to the market because you believe in it, you know what it can do for people and you know the potential is there…

But here’s the only problem. No one knows about your widget yet, you don’t necessarily have any prior experience with widgets, your funds are real low and no one really knows you (you’re not a celebrity, or rich and famous – that part hasn’t become reality yet). Unfortunately you realize, the widget – as incredible and wonderful as it is – will not sell itself. How are you now going to market it and get it out there?

Keeping it secret and not telling anyone about it is surely not going to work. You have to get the word out. So what should you do? You’ve got to think like a business. First of all, take inventory of your resources – make a resources list. What resources do you have at your disposal that you can utilize to get the word out about your widget so people can start buying them?

Well, you spent all the money you had (and didn’t have) to get INTO business for yourself. You might be able to go further into debt and put everything on the line and really live on the edge… But maybe there’s a better idea – what other resources do you have at your disposal?

Then it hits you… The most effective form of advertising is word of mouth. You can start talking to people about your business and share your enthusiasm, belief and vision. You remember how many times your friends have told you about a good movie or good restaurant and you went and checked it out, spending the money simply because of their recommendation – and most of the time that was without even doing any other research. You trusted them at least enough to follow their recommendation.

You then come to realize that you have a whole network of people who already know you, and to some degree like and trust you – at least enough to listen to what you have to say about this incredible, new widget and opportunity you have.

If nothing else, it’s a free form of advertising to help you begin spreading the word while accumulating testimonials from people who try out your widget to help increase your 3rd party “social proof” which you will need when you start talking to people who don’t know you at all. This will help you create a reputation, establish a foundation for you to build from so others can see that hey, this widget IS great! People will see that if this widget worked for Bob and Sue and Phil and Tom as it was supposed to… why shouldn’t they receive similar benefits?

You utilize your resource list (also known as YOUR WARM MARKET) to help you get your business started.

Is that all you should do?

Should you rely SOLELY on your warm market to make your goals and dreams for your MLM home business (or any business) come true?

Well I don’t know how many “widgets” your warm market can purchase but my suggestion is to never rely on only one method for building a business, you need to diversify and implement between 3 and 5 marketing methods at all times in case the market changes (as it does) and for other fluctuations and changes that occur. But by all means it is a valuable resource that every business owner and networker should access for the reasons above and because you never know where your market may lead you, you never know who them know, and so on.

What you definitely do NOT want to do though is hassle and hound your warm market. It’s not necessary, that is the wrong way to approach your warm market in building your MLM home business. Treat your business with the same seriousness as the widget business described above. Don’t portray your MLM home business as some inexpensive, fly-by-night get-rich-quick scheme that you got into yesterday that you’re hoping to get lucky with.

Treat your MLM home business as if you had paid millions of dollars to get it setup and running like the founder of your company had to do before you ever would have an opportunity to make any money. Treat this business like a million dollar McDonald’s franchise because the MLM home business model (like McDonald’s) is already proven.

The only thing unproven is YOU and your ability to be coachable and follow the proven system that has created hundreds and thousands of millionaires in this industry already.

Do you have what it takes to be successful? Are you committed to making it, to becoming successful, no matter what? Or are you just testing the waters with only one foot in? You choose. Choose either that you’re going to make it or you might as well quit and find something else that you can believe in (being in business for yourself is not cut out for everyone, nor is it easy – but it’s definitely worth it).

So, should you approach your warm market to build your MLM home business? Only you can answer that question…