One of the many ways that potential investors or other potential stakeholders can assess the financial health of a company is by using a figure known as EBITDA, or earnings before interest, taxes, depreciation, and amortization. If you are an entrepreneur and attempting to persuade venture capitalists and certain types of investors to supply funding to your start-up, you might choose to highlight your start-up’s EBITDA to show your earning potential.
While EBITDA is useful in many circumstances, there are some drawbacks to relying on this figure. This blog will explore some of the advantages and disadvantages to focusing on an impressive EBITDA.
What is the Value of Using EBITDA to Illustrate the Value of Your Company?
A company’s EBITDA can be an effective way to show its earning power. In other words, if investors want to know the corporate profitability of a target company, EBITDA will likely be the calculation they focus on. To understand the value of featuring EBITDA, it is useful to understand its early uses, which occurred in the 1980s and coincided with the emergence of leveraged buyout investors. These investors were attracted to financially distressed companies and were concerned about a target company’s ability to pay back the interest associated with a restructuring.
Entrepreneurs may also choose to feature EBITDA to compare their company’s financial performance against those of other businesses. It can be useful to compare the EBITDA of a particular company against industry averages to gauge it’s relative financial health and investment potential. Technology companies and other businesses that have to take on large debt loads in the early stages often choose to highlight their EBITDA.
What Does EBITDA Not Show?
The name alone reveals factors that are not included in EBITDA. While it gives the income generation capacity for a company, it does not include the all-important net income figure. Earning power can be enticing to investors, but many will want to know the expenses needed to arrive there.
Savvy investors already understand that the EBITDA of a target company is not the full picture of its finances. The figure itself cannot reasonably be considered deceiving, but one could argue that it constitutes an “error by omission.” Another way of looking at this figure is that it is simply a snapshot in time, and does not account for changes in working capital.
Conclusion
There are countless considerations for investors, entrepreneurs, and business owners to weigh as they evaluate whether to put money into a start-up operation or decide how much to spend. Many of these decisions carry legal implications as well. If you are thinking about investing in a business or inviting others to invest in yours, call Integrated General Counsel at 925-399-1529 to learn more about how we can help protect your interests.
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