Hi all,
I've noticed something unexpected while ramping up in the search fund space. I'm surprised by the emphasis on adjusted EBITDA as opposed to adjusted free cash flow.
Cash is king - it's what you pay your expenses with, it's what we're all trying to generate, and it's possible for a business to be highly profitable but cash strapped. Working capital inefficiency can be a hidden cost within EBITDA.
Additionally, ignoring the capex requirements to produce either income or cash flow isn't intuitive. Neither is excluding taxes unless the business is a sole proprietorship.
I understand that capex can by lumpy, but if that's the concern then EBIT would be the focus over EBITDA. If the concern is financing differences pre- and post-acquisition then Unlevered FCF is a good alternative.
Can anyone provide insight into the apparent preference to use adjusted EBITDA rather than adjusted FCF in this space?
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by a searcher
from Wilfrid Laurier University - School of Business and Economics
in Toronto, ON, Canada
in Toronto, ON, Canada
3yrs ago
Adjusted EBITDA vs. FCF
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by a lender
2yrs ago
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
The market is used to using adjusted EBITDA for calculating list prices. However, you definitely need to do a deeper dive in due diligence. Also, if you have a deal represented by the right broker, you will find adjustments are made for items like CAPEX, buyer salary, etc. When you do not see these items you need to factor them into your own analysis when you make an offer. We make those adjustments all of the time to try and come up with the correct adjusted EBITDA for calculating debt service. I think you will find you often have to enter into the LOI based on the adjusted EBITDA because it is unlikely you will have all of the details you need to calculate the true business cash flow that early on.
However, as a buyer you definitely need to run a cash flow analysis as well and be sure there will be sufficient cash in the business post closing. This often includes making adjustments for the amount of cash staying in the business or the amount of working capital you need to bring into the transaction. I always tell clients that sellers cannot have it both ways. Meaning, they cannot expect to get the highest multiple for their business but then strip of all of the working capital and assets out of the business at close. If they want to keep cash and A/R, they need to accept a lower multiple so the buyer can afford to bring the working capital into the transaction, or if they want the highest multiple on the business, they need to leave adequate working capital in the business post close. I will tell you the working capital issue is usually the number one issue I see come up post LOI to be resolved, and is usually the most challenging issue in ensuring the financing gets done, as no lender wants to fund a deal without adequate working capital.
I am happy to discuss in more detail at redacted Good luck with your search.
However, as a buyer you definitely need to run a cash flow analysis as well and be sure there will be sufficient cash in the business post closing. This often includes making adjustments for the amount of cash staying in the business or the amount of working capital you need to bring into the transaction. I always tell clients that sellers cannot have it both ways. Meaning, they cannot expect to get the highest multiple for their business but then strip of all of the working capital and assets out of the business at close. If they want to keep cash and A/R, they need to accept a lower multiple so the buyer can afford to bring the working capital into the transaction, or if they want the highest multiple on the business, they need to leave adequate working capital in the business post close. I will tell you the working capital issue is usually the number one issue I see come up post LOI to be resolved, and is usually the most challenging issue in ensuring the financing gets done, as no lender wants to fund a deal without adequate working capital.
I am happy to discuss in more detail at redacted Good luck with your search.
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by a professional
1yr ago
from James Madison University in Washington, DC, USA
from James Madison University in Washington, DC, USA
I've been a Deal maker for over a decade past decade, Here's how I think about the 3 datapoints:
Free Cash Flow (FCF):
Free Cash Flow shows how much actual cash the business generates after paying for operating expenses, taxes, and necessary investments (like equipment). It represents the cash available to the business for things like growth, dividends, or unexpected costs. It’s a clearer picture of the business’s financial health than EBITDA, as it accounts for the money that’s truly available after essential expenses.
Cash Available for Debt Service (CADS):
CADS focuses specifically on the cash available to pay off debt. It’s critical if you're taking on a loan (such as an SBA loan) to finance the acquisition. CADS ensures the business has enough money, after operating costs, to make debt payments. Without sufficient CADS, the business might not be able to meet its loan obligations, which could lead to financial trouble, regardless of how profitable it appears based on EBITDA.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): This is a measure of a business’s profitability. It shows how much the company earns from its operations before accounting for non-operational costs like interest, taxes, depreciation, and amortization.
All Three Summarized:
FCF shows you how much cash is truly available after key expenses.
CADS tells you if the business can handle its debt payments.
EBITDA is a good indicator of operational performance but doesn’t tell you how much cash is left to actually pay debts or reinvest in the business.
Free Cash Flow (FCF):
Free Cash Flow shows how much actual cash the business generates after paying for operating expenses, taxes, and necessary investments (like equipment). It represents the cash available to the business for things like growth, dividends, or unexpected costs. It’s a clearer picture of the business’s financial health than EBITDA, as it accounts for the money that’s truly available after essential expenses.
Cash Available for Debt Service (CADS):
CADS focuses specifically on the cash available to pay off debt. It’s critical if you're taking on a loan (such as an SBA loan) to finance the acquisition. CADS ensures the business has enough money, after operating costs, to make debt payments. Without sufficient CADS, the business might not be able to meet its loan obligations, which could lead to financial trouble, regardless of how profitable it appears based on EBITDA.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): This is a measure of a business’s profitability. It shows how much the company earns from its operations before accounting for non-operational costs like interest, taxes, depreciation, and amortization.
All Three Summarized:
FCF shows you how much cash is truly available after key expenses.
CADS tells you if the business can handle its debt payments.
EBITDA is a good indicator of operational performance but doesn’t tell you how much cash is left to actually pay debts or reinvest in the business.
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