The EBITDA Multiple Valuation Trap

Not a day goes by that professionals in the world of buying and selling companies do not discuss EBITDA multiples. For small profitable companies it is the primary metric for valuation. However, not many sellers from my point of view fully understand that EBITDA is not cash flow. Sellers need to realize that EBITDA minus capital expenditures minus net changes in working capital minus cash taxes is the cash flow that is available to amortize acquisition debt and provide some return to the new owner.

This net cash flow number is very important to forecast because if it is not determined accurately the buyout could unravel quickly. The last place a seller wants to be is hearing that the buyer wont be able to make a scheduled debt amortization payment on the note they have taken back. Armed with the knowledge of what the net cash flows look like buyer and seller can come up with a reasonable payback schedule and both parties can achieve their desired goals.