Posts made in February 2019

EBITDA: It’s important to understand it when selling your business

Denver Post | BUSINESS

BY GARY MILLER | | GEM Strategy Management

Posted: February 24, 2019 at 6:00am | Digital Edition

Most business owners have heard of EBITDA, (Earnings Before Interest, Taxes, Depreciation, Amortization), but don’t fully understand how it can affect the value of a company and the price buyers pay for a business. EBITDA is a financial calculation that measures the financial strength of a company. This calculation is often used by financial analysts, investors and potential buyers when valuing and analyzing potential acquisitions. It a meaningful measure of operating performance as it allows businesses and investors to more fully evaluate productivity, efficiency, and return on capital, without factoring in the impact of interest rates, asset bases, taxes and other operating costs.

By minimizing the non-operating effects that are unique to each company, EBITDA allows investors to focus on operating profitability as a singular measure of performance. Such analysis is particularly important when comparing similar companies across a single industry, or companies operating in different tax brackets.

Photo provided by Mark T. Osler

Gary Miller

EBITDA first came to prominence in the mid-1980s as leveraged buyout investors examined distressed companies that needed financial restructuring. They used EBITDA to calculate quickly whether these companies could pay back the interest on various financed deals. The use of EBITDA has since spread to a wide range of businesses. Its proponents argue that EBITDA offers a clearer reflection of operations by stripping out expenses that can obscure how the company is really performing.

EBITDA is calculated using the company’s income statement of net income (Total Revenue
Minus Total Expenses = Net Income) and adding back interest, taxes, depreciation and
amortization. It is important for business owners to understand this metric when selling their
businesses because many businesses are sold by a multiple of EBITDA (for example, a
business might sell for five times EBITDA).

However, EBITDA alone may not reflect the true value of a company. Therefore, a business owner should add back certain expenses that are categorized as discretionary, extraordinary, and non-recurring. This calculation is referred to as “adjusted” EBITDA or “normalized” EBITDA.

When combing through expense accounts looking for add-backs, keep some questions in mind: Were these expenses necessary for the operation of the business? Will a new owner incur these same expenses?

Below are some examples of typical add-backs for each category:

Discretionary: A primary discretionary expense is how much owners pay themselves in salaries and benefits (“perks”), including salaries and benefits paid to family members. It’s not unusual for business owners to pay excessive (i.e. well above market rate) salaries to both family members and longtime employees. “Perks” such as a personal car, entertainment, travel, life insurance policies, rent expense, or even sponsorship of your child’s little league team are purely discretionary. The amounts for these expenses should be adjusted to fair market or normal levels. Negative adjustments would include filling any gaps in the management ranks such as hiring a new CFO after the transaction is completed.

I recently met an antique dealer who traveled with his wife to Europe four to six times a year searching for antiques. Not surprisingly, the associated travel expenses were significant. Was this a legitimate business expense? Sure. Would it be necessary for a new owner to travel the same number of times with his wife to continue operating the business successfully? I doubt it.

Nonrecurring: These are one-time expenses, including moving expenses, cleanup and repairs from storm damage, purchasing new computer equipment etc. It’s reasonable to assume that these expenditures would not be incurred by a new owner.

While I am a firm believer in the EBITDA metric, buyers and sellers should be aware of the pitfalls of relying on EBITDA as the sole measure of a company’s operating performance. For example, if a company’s performance has varied in recent years, the time period for which EBITDA is calculated could significantly influence the implied multiple.

Consider a company that produced an EBITDA of $200,000 last year, has an EBITDA run-rate of $140,000 this year and is expected to produce EBITDA of $260,000 next year.  A 5x multiple would suggest values ranging from $700,000 to $1,800,000 – quite a wide range. So what EBITDA should you use? The proper EBITDA would be a current “normalized” level of EBITDA (which can require significant analysis to ascertain).

Another weakness of EBITDA is that it excludes “CAPEX (capital expenditures) and working capital requirements.” While EBITDA is often mistaken as a proxy for net cash flow, it is important to remember that EBITDA is not equal to net cash flow. “CAPEX” reduces a company’s net cash flow but is not factored into an EBITDA calculation since CAPEX does not hit the P&L statement. Also, as companies grow, higher levels of inventories, receivables, and other working capital assets are required to support higher revenue levels.

These investments are a use of future cash but are not reflected in EBITDA. Since most buyers look to future growth in cash flow, growth cannot be captured in a static EBITDA or an adjusted EBITDA calculation.

Often, multiples are assumed based on the expectations and experience of business owners and their advisers. While it is commonplace to hear about multiples of 5x to 10x, there are many industries where EBITDA multiples can be much higher or lower. Also, company-specific factors should influence the selection of an EBITDA multiple. Assessing the proper multiples of EBITDA requires in-depth analysis of companies within the same industry, geography, size (revenues, assets, employees), growth rates, margins and profitability.

While an EBITDA multiple can assist in developing a proxy for value, this should be done only after careful analysis of the factors above. In addition, the analysis should be supplemented with a comprehensive discounted cash flow analysis, which can reflect a company’s projected growth in revenues, profits and cash flows.

Finally, be prepared to defend any add-backs that you include in your adjusted EBITDA. Not surprising, discussions about add-backs with a buyer can become contentious. A savvy buyer will expect you to be able to justify each add-back and explain it in detail.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. He can be reached at 970-390-4441 or

Funding stages from startups to IPOs

The Denver Post | BUSINESS

by GARY MILLER | | GEM Strategy Management, Inc.

PUBLISHED: January 27, 2019 at 6:00 am | UPDATED: February 5, 2019 at 5:49 pm

Robert was well on his way growing his startup to a viable commercial enterprise thanks to his “Founders” financing among his family, friends and his own resources. However, like so many startups, Robert was running out of cash. While his customer base was steadily growing, his monthly expenses (“burn rate”) was exceeding his monthly revenues –- forcing him to use up capital faster than he had planned from his initial capital raise.

Robert realized that he needed to raise more capital to expand his operations and achieve his profitability goals. Robert is not alone. Successful startups need to raise capital through a series of external capital raise stages. Robert could potentially need five major capital raises, or more, to realize the full potential of his company. There are five major funding stages before you can plan on exiting through an IPO.

First — Founders Funding Stage

The earliest stage of funding in a new company comes so early in the process that it is not generally included among funding rounds. Known as Founders funding, this stage typically refers to the period in which a company’s founders are launching their operations. The most common funders are the founders themselves, as well as close friends, family and supporters.

Second –- Seed-Funding Round

Seed-funding is the first official equity/debt funding stage. It typically represents the first official money that a business venture raises. Think of “seed” funding as an analogy for planting a tree.

This early financial support is ideally the “seed” that will help to grow the tree (the business). Seed-funding helps a company to finance its first steps, including market research, product proto-types and proof of concept. With seed-funding, a company can fund its final product development, identify target markets and the team to complete these tasks.

Many potential investors include founders, friends, family, incubators, venture capital companies and “angel” investors. These groups tend to appreciate riskier ventures (startups with little proven track records). However, they expect either convertible debt or equity in the startup in exchange for their investments.

While seed-funding rounds vary significantly in the amount of capital they generate for a new company, it’s not uncommon for these rounds to generate from $200,000 to $2 million for the startup in question. Many startups raising seed capital are valued between $1.2 million to $6 million.

Third –- Series A Funding Round – “Optimization Stage”

Once a business has developed a track record (an established customer base, or consistent revenue streams), the founders may want to continue raising money to optimize their customer target markets, products and service offerings. In a Series A funding round, it is important to have a strong Strategic Business Plan for developing a business model that will generate long-term profits. Typically, Series A rounds raise approximately $2.5 million to $25 million or more due to the high-tech industry valuations.

Series A funding investors are looking for companies that can produce long-term profits and maintain both a competitive advantage and strong bench strength in its management ranks. Fewer than half of all successful seed-funded companies will attract the attention of Series A investors because of weaknesses in those three areas.

Fourth –- Series B Funding Round — “Building Stage”

Series B rounds are all about taking a successful business past the optimization stage to the next level — expanding its market reach. Companies that have gone through Founders, Seed and Series A funding rounds have developed substantial customer bases and have proven to the investment community, that they are prepared for success on a larger scale.

Building a successful product and growing a winning team requires quality talent. Such talent is responsible for bulking up business development, advertising, technology, and customer support. Success in these areas is critical in this stage.

Series B funding appears similar to Series A funding in terms of processes and key players. Series B funding is often led by many of the same players as in the earlier round, who include a lead anchor investor who helps draw in other investors. The difference between Series A investors and Series B investors is the addition of a new wave of venture capital firms or private equity firms that specialize in the “Building Stage” of funding.

Estimated capital raised in a Series B round tends to be between $25 million and $100 million or more. Valuations for these well-established companies varies between $100 million and $250 million or more.

Fifth –- Series C Funding Round –- “Scaling Stage”

Businesses that make it to a Series C funding stage are very successful. These companies look for more funding to help them develop new products, additional services, to expand into new markets, and to acquire other companies. In this stage of funding, investors inject significant capital focusing on “scaling” the company, growing it as quickly and as successfully as possible.

Investors’ expectations are to receive more than double their investments when they exit the firm. One of the fastest scaling strategies is M&A –- particularly acquisitions. This strategy can accelerate market reach by purchasing companies in North America, Europe and Asia.

Since Series C round companies typically have reached target customers coast to coast in the U.S., inorganic growth (buying companies) is less costly than organic growth (generating additional sales from existing customers) once an enterprise reaches critical mass.

Series C funding groups, hedge funds, investment banks, private equity firms and large secondary market groups become the major investors. They believe that the company is less risky, therefore more investors come to play.

Most commonly, a company will end its external equity funding with Series C funding. However, some companies can go on to Series D and even Series E rounds of funding. But, generally Series C funding rounds can generate hundreds of millions of dollars to scale globally. Many of these companies utilize Series C funding to help boost their valuations in anticipation of an IPO (Initial Public Offering). Companies at this stage enjoy valuations of $100 million or even into the billions.

Therefore, Series A, Series B, and Series C funding rounds, refer to growing a business through a progressive amount of funding rounds designed to focus on specific company objectives. Series A, B, and C funding rounds are merely stepping stones in the process of turning a successful startup into a commercially viable firm, potentially leading to an IPO.

The time it will take Robert to navigate these five funding stages (assuming he wants too and can attract investors for each round) is unpredictable. Some companies can be very successful after only a “seed” round or a Series A, or even sub-Series A1 or A 2 with smaller raises. But, for most entrepreneurs, they will need four or five large rounds of funding before they can reach for an IPO.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. He can be reached at 970-390-4441 or

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    2019 could be the best year ever for selling your business

    The Denver Post | BUSINESS

    by GARY MILLER | | GEM Strategy Management

    POSTED:  December 23, 2018 at 6:00 am

    Over the past several weeks, I’ve been asked by several business owners whether they should sell their businesses in 2019 or hold off until 2020 or 2021. I told them, “Do not wait.” One of the biggest mistakes business owners make is postponing the sale of their businesses in hopes of selling at a higher price some time in the future. More often than not, they mistime the market.

    No one can accurately predict with any degree of certainty what the market will look like in two to three years. Even today, some experts predict that we are headed for a recession sometime during 2019 through 2021.

    I do not believe the pessimists. The “Index of Leading Economic Indicators,” the best predictors of the fundamental strength of the economy, strongly suggests that at least in the short term, the next 12 months to 18 months, shy of a major geo-political event like 9/11, the economy will stay strong.

    As small- and- medium-sized businesses embrace a strengthening economy, there is another reason for entrepreneurs to be optimistic. It is a seller’s market. Some advisers say it’s the best market for mergers and acquisitions they have ever seen, certainly in recent years. Even small business owners who aren’t yet ready to retire are looking to take advantage of this robust M&A environment.

    In the Pepperdine Private Capital Market Study, business advisers state that seller sentiment hasn’t been this high in the past five years. My colleagues tell me many active buyers are working on multiple deals simultaneously, which has not been seen in past years –- or, at least, not at the volume we are seeing today in the lower-middle market.

    Separate research reported in Forbes Magazine confirmed those findings. According to Forbes, published a few months ago, nearly one-third of small business owners plan to sell their businesses within the next two years. The majority of business buyers –- 84 percent –- plan to buy in the next year.

    I am advising our clients, if their companies are prepared to go to market, sell now! You may not get another chance like this for another five to seven years. Valuations are high and buyers are paying premiums for well-run companies.

    However, business owners shouldn’t rush to sell their businesses simply because the market is strong. Analysts insist that to maximize value, business owners must prepare their business for sale before going to market. Buyers have become much more cautious and sophisticated in their due diligence processes since the Great Recession of 2008-2009.

    Today, 15 major areas that buyers look at closely when examining a company to purchase are the company’s:

    1. Historical financial statements and related financial metrics, as well as the reasonableness of the target’s financial projections of its future performance;
    2. Technology/intellectual property;
    3. Customer base, its concentration and sales pipeline;
    4. Strategic fit with the buyer’s organization (cultural);
    5. Contracts and commitments to suppliers, employees, contractors, lenders and senior management;
    6. Past, present and potential future litigation;
    7. Tax matters and understanding of any tax-loss carryforwards;
    8. Governance documents and general corporate matters;
    9. Overall operations and its cybersecurity protocols;
    10. Related party transactions;
    11. Regulatory filings and compliance issues;
    12. Production/sourcing/suppliers and related matters for products and services offered by the target company;
    13. Marketing and sales strategies and agreements related to the sales of the company’s products and services.
    14. Competitive landscape and market analysis of the industry sector the target company serves; and,
    15. SWOT (strengths, weaknesses, opportunities and threats) analysis.

    Because buyers will slice and dice numbers every way possible to understand the business and any problems, risks and opportunities going forward, sellers can prepare their companies by putting themselves through the same due diligence process as buyers do to shore up the “soft underbelly” of the companies. It is always better to identify any “warts” in a business before going to market, versus during a buyer’s due diligence process. No one likes surprises. If buyers discover problems during the due diligence review, that was not disclosed by the seller in advance, it will usually cost the seller significantly.

    I recommend to clients during the preparation to sell their businesses that they understand two major metrics about their businesses: (1) A valuation of their business conducted by an independent certified valuation firm so they don’t over price or underprice their businesses and, (2) A benchmarking study focusing on how they stack up against competitors in their industry. A comprehensive benchmarking study can focus on the due diligence items listed above. Both of these analyses and studies will point out key performance areas that are strong and/or could be problematic in the transaction process.

    One new issue that is hurting some sellers in closing their transactions is their inability to attract new talent and retain current employees in this environment of record-low unemployment. In a separate report from Wells Fargo and Gallup published a couple of months ago, nearly one-fifth of small business owners cited hiring new staff and retaining current employees as their biggest challenge. Some experts note that the struggle to hire new talent is squeezing businesses’ organic growth efforts, making companies less attractive to buyers.

    Given this current labor shortage environment, I am recommending to some of our clients that they consider inorganic growth (acquisition strategies) vs. organic growth only (build from within) as a part of their overall exit plan. A smart acquisition, such as purchasing a competitor’s well-run company, can add significant enterprise value, and therefore add significant shareholder value. In today’s market a solid acquisition, rolled up into your current company’s operations, can add more diversification, lower your risk profile and generate increased revenues and earnings.

    Regardless of which strategies are employed, now is a good time to plan your exit strategies and prepare your company for sale. I remind them that “a bird in hand is worth two in the bush.”

    Gary Miller is CEO of GEM Strategy Management Inc., which advises business owners on how to sell their businesses or how to buy companies and raise capital. He can be reached at 970-390-4441 or