What is EBITDA?

For buyers conducting due diligence on a potential acquisition, EBITDA is often the starting point for valuation multiples and a key indicator of a business's capacity to service debt or generate returns. It strips away non-operational expenses like interest (which depends on financing structure), taxes (which vary by entity type and jurisdiction), and non-cash expenses like depreciation and amortization (which reflect past capital expenditures rather than current operating performance). This makes it easier to compare the operational efficiency of different businesses, regardless of their capital structure or accounting policies, providing a cleaner look at core business performance.

However, relying solely on EBITDA can be misleading. Its primary weakness lies in ignoring capital expenditures (CapEx) to maintain or grow the business. A seemingly high EBITDA might be unsustainable if the business requires substantial ongoing CapEx for equipment upgrades or software licenses, effectively eroding the cash available to an owner. Smart buyers will always look at 'adjusted EBITDA,' which adds back non-recurring expenses or owner benefits, as well as considering a business's necessary CapEx to arrive at a truer 'free cash flow to firm' or a figure more akin to 'seller's discretionary earnings' (SDE) for smaller businesses.

A common mistake is treating EBITDA as actual cash flow. While it's a useful proxy, it doesn't account for changes in working capital, capital expenditures, or debt repayments – all of which impact the real cash an owner can take out or reinvest. For startups, projecting EBITDA helps validate the core business model's profitability before financing and tax implications. When presenting to investors, a solid EBITDA projection demonstrates the underlying power of your unit economics and operational efficiency, signaling a viable long-term opportunity.