The unending focus on EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) can cause problems. Moreover, I have been seeing more and more people with little experience in mergers and acquisitions being given more responsibility for deals. So the encounter I had this week with an M&A type from Spy, Inc. wasn't really surprising.
If we purchase Spy, Inc., there will be significant one-time costs, the source of which isn't particularly important, just after the transaction. Consequently, it will be 7 months before the firm is actually back in the black after these one-time charges. Because, at least at this stage, we aren't particularly concerned with developing a discounted cash-flow valuation EBITDA with non-recurring costs removed isn't really something I care about. What I care about is the outflows of cash in the first six months that Sub Rosa will either have to cover directly, obtaining financing or increase the existing line of credit for or get the seller to cover. I had modeled this but on discussing our model with the Spy, Inc. people I met resistance.
EBITDA, I was matter-of-factly informed, should be exclusive of non-recurring costs when used in a financial model. I tried to point out that I wasn't doing a valuation, I wasn't, yet, interested in the intrinsic value and theoretical profitability of the company. I was far more interested in what Sub Rosa was going to have to stomach out of pocket to turn the division of Spy Inc. we were considering buying into a stand alone company. I got nowhere. I also got nowhere trying to explain that I wasn't going to amortize capital improvements for this particular model because someone was actually going to have to write a big check for the full amount of capital improvements in the first 90 days after buying the company. Amortizing it might make for better accounting going forward, but for the moment I was worried about the first 90 days of negative cash flow. Response: "But you have to amortize capital improvements." Ugh.
It is a symptom of the low unemployment rate in the business that you sometimes run into people who scored solid A's in their accounting or financial statements analysis classes in business school but have no idea what the issues confronting an acquirer post-transaction actually are.