No pilot would fly using only one instrument, yet dealmakers routinely want to price companies based on the single metric of EBITDA. There is, however, a little method to this madness. EBITDA and its multiple are imperfect but workable. They provide a common language for early-stage conversations about value, and they are useful in the hands of people who understand what they are and critically, what they are not.
Every few years, the M&A world rediscovers its scepticism toward EBITDA as a measure of profitability. Articles circulate declaring it meaningless or deceptive, reviving Charlie Munger’s quip that it’s “bs earnings.” The criticism is not entirely misplaced as Adjusted EBITDA is often manipulated beyond any level of plausibility and presented in ways that deliberately obscure economic reality. But the critics are mostly attacking a tool for a job it was never designed to do.
EBITDA is a useful proxy for operating profitability. Its multiple is a useful shorthand for enterprise value. Both have known limitations, and both are dangerous in lazy hands. But then again, so is every other financial metric.
The Most Important Point Isn’t Even About EBITDA
Before defending EBITDA itself, consider the more fundamental problem with how it’s used in valuations.
In middle-market transactions, EBITDA multiples routinely span 4× to 8×, depending on growth profile, customer concentration, and strategic relevance. That spread is enormous and means that getting an EBITDA calculation exactly right while applying a wide-ranging multiple produces a valuation that’s wildly off. The obsession with EBITDA precision is, in that sense, a distraction from the much larger source of uncertainty sitting right next to it.
More importantly, this way of thinking gets the causality backwards. EBITDA multiples don’t drive valuation. They are an outcome of all the considerations that go into the realised price at closing.
EBITDA doesn’t need to be a perfect measure. It just needs to be good enough to support a conversation about approximate value. If interests align at that point, the real analytical work can begin.
This rather reframes the whole debate. EBITDA’s role is to get two parties into the same room with compatible expectations, not to determine the final number.
EBITDA Has Been Pressed Into Action as a Valuation Heuristic
At its core, EBITDA isolates operating profitability before financing structures, tax jurisdictions, and non-cash accounting treatments distort comparability. That’s genuinely useful as such normalizations provide a relatively standardized lens through which buyers evaluate operating performance.
Consider a number of identically operating businesses with different tax and financing structures. Although their Net Income will vary considerably, their EBITDA will be exactly the same, which is why EBITDA can be a useful comparative measure.
| Business | Revenue | Operating Profit | Interest | Tax | Net Income | EBITDA |
|---|---|---|---|---|---|---|
| Co. A: No Debt, Low Tax | $10M | $2.0M | $0 | $0.3M | $1.7M | $2.4M |
| Co. B: Leveraged, High Tax | $10M | $2.0M | $0.5M | $0.45M | $1.05M | $2.4M |
| Co. C: Offshore Structure | $10M | $2.0M | $0.2M | $0.05M | $1.75M | $2.4M |
Three identically operating businesses with different structures. Net Income diverges significantly; EBITDA remains constant, illustrating its utility as a cross-company operating proxy.
Critics are correct that EBITDA ignores capital expenditures, working capital requirements, debt servicing, and the reality that depreciation usually equates to future investment needs. A manufacturing company cannot pretend capital replacement costs do not exist, which is why EBITDA is a lot less meaningful for them than EBIT. A professional services firm with very few real assets can use EBITDA without it being disconnected from net cash outlays.
Despite its shortcomings, EBITDA was pressed into service as a profitability measure because it makes a few calculations simple. In addition to enabling comparisons, it also serves as:
- Operating cash flow proxy. A loose but workable stand-in for operating cash generation, useful at early deal stages before full cash flow analysis is warranted.
- Debt service coverage. For leveraged acquisitions, EBITDA approximates the cash flow available before debt service, which is why it anchors many bank loan covenants.
- Non-cash charge removal. Depreciation and amortization are accounting constructs that don’t match when cash is actually left the business. Removing them lets the analyst add back specific capex assumptions appropriate to the business, rather than inheriting an accounting-driven number.
EBITDA became the dominant language of dealmaking because it’s simple, consistent, and widely understood. That’s a very useful feature.
EBITDA Is Not Always Appropriate
EBITDA is a poor metric for capital-intensive businesses. A manufacturing company cannot pretend that equipment replacement costs don’t exist, For these businesses, EBIT (which retains depreciation) is the more appropriate reference. Similarly, high-growth software companies are often valued on ARR, sidestepping losses incurred to fuel growth. The right metric depends on the type of business, but will be widely accepted within the relevant industry.
The more serious practical problem stems from how management teams present EBITDA to boards and buyers, as though it were free cash flow, which for high-capex industries, it isn’t. EBITDA ignores working capital requirements, maintenance capex, and debt service. A business generating $10M of EBITDA may be producing very little net cash after those obligations. Sophisticated buyers know this, but the conflation persists.
Adjusted EBITDA Can Be Abused
Adjusted EBITDA is supposed to account for activities that would not be part of the go-forward operation, where their inclusion would distort a real or normalized EBITDA figure. When used reasonably, these adjustments are helpful to both sides of a transaction. However, they can become absurd when businesses begin removing unavoidable operating costs under the guise of normalization. Frequent culprits that give normalizations a bad name are:
- One-time expenses that somehow recur every quarter
- Excluded founder compensation, despite needing to be replaced at market rate
- Customer acquisition costs reframed as investments rather than operating realities
- Rent removed (because a buyer could choose to go remote, naturally)
The EBITDA Multiple Is Also a Proxy
An EBITDA multiple is shorthand for a great deal of context that can’t be fully compressed into a single number.
A 6× multiple on a professional services firm with sticky client relationships and durable margins is a reasonable market price. That same 6× on a high-growth firm with defensible differentiation would be a significant undervaluation. The number means something only when you understand what kind of business you’re looking at.
More importantly, the EBITDA multiple is not an input to valuation, it’s a derived output. When a deal closes, the achieved multiple is, by definition, market for that business. A seller who accepted a 5× multiple received market price for how that business was positioned and sold. Were the same seller to engineer a 9× multiple, they would also have received market price, albeit for a better-positioned business, or a better process. “Market multiple” doesn’t mean anything without that context.
Where Real Value Gets Created
Standalone EBITDA says nothing about strategic value, and that’s where the real money is. Strategic value is what turns a 5× multiple into 10× or even 20×.
When Adobe acquired Semrush, it paid a 77% premium to the unaffected share price. That premium reflects Adobe’s ability to integrate Semrush’s search and AI content intelligence into its existing creative and experience platforms, creating compounded value neither business could generate independently. No refinement of Semrush’s EBITDA calculation would have moved that number.
Private equity roll-up strategies work similarly. Five businesses each acquired at 6× EBITDA don’t simply add up to a portfolio worth 6× aggregate EBITDA. A larger, more integrated business often commands a 10× or higher multiple at exit. That multiple arbitrage and not EBITDA precision is the engine of value creation in lower and middle-market acquisitions.
Strategic framing can move valuation by multiples of what any EBITDA adjustment will achieve. Optimizing the base figure is the refuge of advisors who don’t understand the business well enough to do anything more valuable.
Valuation Is a Multi-Variable Outcome
Valuation has many input dimensions that are reduced to EBITDA and its multiple for convenience. But when actually pricing a deal, EBITDA is only useful when considered alongside numerous other metrics that contribute to the value of the target and after the fact, to the derived EBITDA multiple.
Financial Valuations
When market multiples are discussed, they typically refer to the multiples that apply to a Financial Valuation, that is, business value substantially derived from the company’s ability to continue growing and producing profits as a standalone entity. For marketing agencies and other professional services firms, the derived EBITDA multiple might be 4× for a stable but low-profit business, to 7× for a high-growth, high-profit business with a strong customer base.
Financial Determinants of Valuation
Experienced buyers will quickly determine whether EBITDA represents genuine operational earnings power or merely accounting cosmetics. The financial drivers that underpin (or undermine) a standalone valuation are:
Core operating growth & profitability
Revenue quality
Customer concentration & churn
Margin durability & scale
Working capital dynamics
Capital intensity
Cyclicality
Management dependency
Cash conversion characteristics
Experienced operators can usually tell within an hour if the financial story is holding up, so egregious liberties with reported EBITDA are not worth the effort or credibility risk. Unfortunately, many sellers and their advisors have their causality backward, believing that stretching EBITDA directly leads to a higher valuation.
While this doesn’t invalidate EBITDA as a proxy or as part of a wider set of factors, it underlines the importance of thoroughly understanding the business being bought. This is especially true when you consider that EBITDA, even when projected forward, is a measure of the profitability of the standalone business and has no bearing on its strategic value.
Strategic Valuations
Strategic buyers will pay a premium because they can extract value unavailable to financial sponsors or standalone operators. So the same firm achieving a derived EBITDA multiple of 7× might realize another 1–2× for the ability to cross-sell extensively across buyer and seller customer bases and another 7–10× if their capabilities open up new offerings, segments, and enterprise customers.
This is incredibly important. Fiddling with super-accurate (or conversely super-adjusted) EBITDA nets marginal gains. Understanding the strategic opportunity, which is subtle and needs to be enticed out of the transaction process is where the real value is created.
Strategic Determinants of Valuation
Strategic buyers pay premiums for value they can extract that a standalone operator cannot. These are the levers, invisible in any EBITDA calculation, that drive the premium above market multiples:
Cross-selling into existing customer bases
Geographic expansion
Vertical integration
Elimination of duplicated overhead
Partnership or alliance leveraging
Intellectual property integration
Accelerated market entry
Data or platform consolidation
Conclusion
Every valuation methodology is imperfect. DCF models depend heavily on terminal value assumptions. Comparable company analysis inherits market irrationality and the prevailing assumption that the companies are even comparable. Precedent transactions reflect competitive auction dynamics and timing. There is no clean answer.
EBITDA and its multiple are imperfect but workable. They provide a common language for early-stage conversations about value, useful in the hands of people who understand what they are, and critically, what they are not.
The real work of valuation isn’t about computing a number more precisely. It’s about understanding the business, its competitive position, and what a buyer can do with it that neither party can do alone. This is often the most valuable aspect of an acquisition and the least quantifiable in advance.
A flawed EBITDA times a flawed multiple is perfectly fine for back-of-envelope math. Just don’t confuse it for a valuation.