pebitda versus ebitda

PEBITDA Versus EBITDA

Almost always when the discussion of business valuations arise, the terms of EBITDA or EBIT and PEBITDA or PEBIT are part of the discussion…. But what do they mean? And when do you use one instead of the other? Or do they both simply arrive at the same conclusion when finding a valuation figure? If you are interested in knowing the differences between PEBITDA Versus EBITDA, continue reading this articles for answering all of your questions.

PEBITDA = Proprietor Earnings Before Interest, Tax, Depreciation & Amortization.

EBITDA = Earnings Before Interest, Tax, Depreciation & Amortization.

EBITDA finds an earnings amount of the business before other variables influence it. This can be thought of as the profit of the business’ operations before non-cash charges and interest affect the amount.

For SME this number tells a story about the health of the business, its ability to generate profit for the owner/s and the business’s sustainability i.e. EBITDA is an important consideration when determining if this is a good investment for someone to buy.

SME by nature operate with a very low but Positive EBITDA, or even negative EBITDA, depending on the expense flows of the business for a specific period of time. Reason being;

  • The owner(s) often pay themselves any profits of the business as wages, and hence the EBITDA is often close to $0.
  • Existing owner/s expense favourably for themselves, which is not necessary for the normal operations of the business. I.e. company car, travel, entertainment expenses for employees etc.

The question then becomes to a potential investor;

  • Firstly, if I buy this business and pay someone to take the place of the current owner will I make any profits after I pay this person to run the business? Meaning is it profitable without my input day to day.
  • Secondly, if so, what should I pay for this?? What is the value?? Or if the buyer DOES want to run the business, how much are they expected to earn as a salary? Is the company profitable after they pay themselves a market salary?

For SME’s, using a traditional valuation technique of assigning a multiple to EBITDA, designed for larger corporations is not the most appropriate measure due to the unique nature of SME’s and the value of EBITDA. For example, think of a small café where the owner manages the business day to day, and we use a multiple of 5 on an EBITDA of $10 = a valuation of $50. When the owner is paying themselves $200,000 in wages…. This does not seem right, buying a business for $50 that generates a $200,000 wage for the owner.

Below is an example of 3 companies, same industry, same products and services, 3 different owners wages but all with the same EBITDA, would you value all 3 companies the same?

pebitda ebitda

PEBITDA finds a better solution to answer this question…

PEBITDA = Proprietor Earnings Before Interest, Tax, Depreciation & Amortization.

The objective of PEBITDA is to find a more accurate indication of the business’s profitability taking into account the “proprietor’s” (owners) wage.

PEBITDA = EBITDA (addback) + one (1) proprietor’s wage.

The standard practice is to add back only one proprietors wage should there be multiple owners.

To the three examples above, all other factors being equal across the 3 businesses, (meaning we apply the same multiple to the PEBITDA, for example 2.5), the buyer is purchasing a business with profits for their efforts (the proprietors wage) of $X, if they can continue performance to the same level. See below extended examples.

pebitda

Remember* PEBITDA = EBITDA (addback) + one (1) proprietor’s wage

Business 1:  PEBITDA = EBITDA ($10,000) + Proprietor Salary ($145,000) = $155,000

The next important question is, are the wages of the proprietor ‘market value’, the answer to this question then helps the potential buyer understand what profitability there will be if they pay someone a market salary to manage the business. See below example.

In each of the businesses the market wage of the proprietor is the same.

pebitda enterprise value

Important note:
A business that can create enough profits as to remove the involvement of the owner and have a significantly positive EBITDA should have a higher multiple applied when identifying the enterprise value, than a business that needs to use PEBITDA to generate a significant enough positive PEBITDA.

Reason being is, in the PEBITDA example the owner is still involved in the day to day running of the business, i.e. like an employee to receive a wage/profits(Less attractive sales proposition).

Comparing business’ 1 & 3 from the examples.

  • A higher multiple should be applied to Business 3 based on the adjusted EBITDA than Business 1 based on PEBITDA.
  • Reason being a business that can generate $225,000 in profits without the owner needing to work themselves in the business day to day to generate $145,000 as in Business 1, is more valuable.
  • This information is not known by simply looking at EBITDA without taking into account the owners wage.

So how do you identify what the difference in the multiple would be between EBITDA verses PEBITDA for the same business?

Take business 3 for example. Applying the same multiple to the PEBITDA or adjusted EBITDA gives you a very different enterprise value. Is this correct? Obviously not. A higher weighting should be placed on the metric ‘Adjusted EBITDA’ because the owner will receive profits without having to work day to day for them

pebitda of a company

The applied multiple obviously has many variables that are considered and influence the multiple that is ultimately applied to the earnings metric. This exercise is on the basis that all other factors are considered equal.

Identifying the delta, or difference in the change between an EBITDA and PEBITDA multiple is not as simple as a pure sliding metric, or constant percentage increase across the board. There are a number of variables that need to be considered. This requires the expertise and discretion of industry professionals to establish a fair adjustment.

Here at InteleK this analysis is something that will continue to evolve and be refined. Hopefully from this article it will generate discussions with industry professionals that will shed some new light and we can continue refining the process.

Summation:

  • EBITDA or EBIT as an earnings metric in a company valuation is traditionally more useful for larger companies where the EBITDA is positive and not significantly impacted by the salary or wages of the owner / director.
  • PEBITDA as the earnings metric to apply an appropriate multiple to, becomes more appropriate for small businesses where the owner / director is heavily involved in the day to day running of the business and their wages and personal expenses through the business heavily influence the EBITDA figure.
  • In the PEBITDA calculation the identification of fair market wages for the position of the owner / director needs to be factored in.
  • All other factors being considered equal, a weighting to the multiple used for EBITDA or EBIT to PEBITDA or PEBIT needs to be applied. What this weighting is and how it is calculated needs expertise and discretion of industry professionals to establish a fair adjustment.

PEBITDA is often the most appropriate earnings metric to use when analysing small to medium sized businesses as part of a business valuation. It is more appropriate than the traditional business valuation techniques or methods reserved for larger business, which do not adequately reflect the unique circumstances of SME. Using appropriate techniques and earnings metrics is key in developing accurate and justified business valuations.

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InteleK Australia

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