EBITDA vs Revenue: What Buyers Really Want

When selling your business, understanding what buyers care about most can make a big difference. For lower mid-market businesses (those with $1M–$10M in revenue), buyers prioritize EBITDA over revenue. Why? EBITDA reflects profitability and cash flow, while revenue only shows total sales without accounting for costs.

Buyers often use EBITDA multiples (e.g., 4x–6x EBITDA) to determine a business's value. This means increasing EBITDA can directly boost your sale price. Revenue, while important, plays a secondary role in valuation discussions, as it doesn't reveal how efficiently a business turns sales into earnings.

Key Takeaways:

• EBITDA shows profitability and operational performance. Buyers use it to assess cash flow and calculate valuations.
• Revenue highlights total sales but doesn't account for costs or profitability.
• Boosting EBITDA (e.g., by reducing expenses or adding back one-time costs) can attract more buyers and higher offers.
• Industries with stable cash flow favor EBITDA, while high-growth sectors may lean on revenue multiples.

If you're preparing to sell, focus on improving EBITDA to align with buyer expectations and maximize your business's value.

1. EBITDA

Definition and Calculation

EBITDA, which stands for , is a financial metric that strips away non-cash and financing costs to provide a clearer view of a company's core cash-generating ability. While it isn’t recognized under Generally Accepted Accounting Principles (GAAP), EBITDA is a widely accepted tool for evaluating companies, especially in acquisition scenarios.

Here’s how you can calculate EBITDA using two common formulas:

• EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization
• EBITDA = Operating Income + Depreciation & Amortization

For example, consider a company generating $100 million in revenue, with $60 million in combined costs and $10 million in depreciation and amortization. The operating profit would be $30 million. After accounting for a $5 million interest expense and applying a 20% tax rate, adding back the non-cash expenses results in an EBITDA of approximately $40 million.

This straightforward calculation is one reason why EBITDA is such a key metric in valuation discussions.

Role in Business Valuation

EBITDA plays a central role in valuing companies, particularly in the lower mid-market. By removing variables like taxes, interest, and accounting differences, it provides a standardized way to compare businesses. This allows potential buyers to focus on operational performance without being distracted by variations in tax structures, financing arrangements, or accounting practices.

Private equity firms and strategic buyers often use EBITDA multiples - like the EV/EBITDA ratio - to assess a company’s value. The size of a company's EBITDA can significantly influence buyer interest. For example:

• Private equity firms often target businesses with EBITDA below $1 million.
• Companies with EBITDA in the $1–$3 million range tend to attract strategic bolt-on buyers.
• Sophisticated buyers typically pursue businesses with EBITDA exceeding $5 million.

Understanding these valuation dynamics is critical for sellers who want to position their businesses to meet buyer expectations.

Operational Insights

EBITDA offers a lens into a company’s core operational profitability. It helps buyers evaluate efficiency and performance through benchmarks like the average U.S. EBITDA margin, which stands at 15.68%. A higher EBITDA margin signals better control over operations and pricing power, making the business more appealing to potential acquirers.

Limitations

Despite its advantages, EBITDA has notable shortcomings. It excludes essential cash flow elements, which can present an incomplete picture of a company’s financial health. Warren Buffett, CEO of Berkshire Hathaway Inc., famously criticized EBITDA, saying, "References to EBITDA make us shudder", and asked, "Does management think the tooth fairy pays for capital expenditures?". His pointed remarks highlight a key flaw: EBITDA ignores the cash needed to sustain and grow a business through capital investments.

While EBITDA is undoubtedly useful, it’s important to recognize its limitations and complement it with other financial metrics for a well-rounded assessment.

2. Revenue

Definition and Calculation

Revenue represents the total income a business generates from its sales and operations before deducting any expenses. As the first line on an income statement, it highlights a company's raw earning potential. For lower mid-market companies, annual revenues generally fall between $5 million and $50 million, setting them apart from smaller businesses. For instance, if a company earns $25 million from product sales and $10 million from services in a year, its total revenue would amount to $35 million. While this figure provides an essential starting point for valuation, it doesn't reflect profitability.

Role in Business Valuation

Revenue plays a critical role in assessing a company's worth, but its contribution to valuation requires careful interpretation. In the middle market, revenue often aligns with enterprise value ranges between $10 million and $1 billion, serving as a baseline for valuation discussions. However, while revenue showcases a company's ability to generate sales, it doesn’t provide a complete picture of its financial health or operational efficiency.

Operational Insights

Revenue offers a clear snapshot of a company's market position and growth potential. It reflects the business's ability to attract customers and drive sales - key factors in its overall success. Trends in revenue growth can reveal insights into market demand, competitive strength, and the effectiveness of sales and marketing strategies. For example, a manufacturer generating $30 million in revenue might appeal to private equity firms looking for opportunities to enhance operations. Additionally, analyzing revenue can uncover seasonal patterns, customer concentration risks, or market dependencies that could influence future performance.

Limitations

While revenue is an important metric, it has its shortcomings when viewed in isolation. One major limitation is that it ignores operating expenses, which can obscure a company's actual profitability. For example, a business might generate $50 million in revenue but spend $48 million on operating costs, leaving a slim profit margin. Although revenue is a standardized GAAP metric that enables comparisons across companies, it doesn’t account for variations in cost structures, operational efficiencies, or capital needs. Moreover, high revenue achieved through unsustainable practices - such as one-time contracts, aggressive pricing, or excessive customer acquisition costs - may not translate into lasting value.

Revenue vs. EBITDA: What Really Drives Valuations?

EBITDA vs Revenue: Comparison

When it comes to valuing a business, buyers approach EBITDA and revenue from different angles. Both metrics show up on financial statements, but they serve distinct purposes in evaluating a company's operational performance and overall value.

Revenue represents the total income generated by a business, but it doesn't account for the costs involved in making those sales. This makes it less useful for assessing whether a company can maintain its earnings after an acquisition. On the other hand, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) offers a clearer picture of operational efficiency, which is why it often takes center stage in valuation discussions.

One key difference is standardization. Revenue follows GAAP (Generally Accepted Accounting Principles), ensuring consistency across industries. EBITDA, however, is a non-GAAP metric, meaning its calculation can vary. Despite this, buyers tend to favor EBITDA because it provides insights into how well a company manages its costs and generates cash flow. This is especially true for businesses with stable cash flows and predictable earnings, where EBITDA is frequently used as a primary valuation metric.

Here’s a quick breakdown of how EBITDA and revenue differ:

Criteria	EBITDA	Revenue
Profitability Insight	Reflects earnings after operating expenses	Shows total sales without profit details
Operational Efficiency	Highlights cost management	Offers no insight into cost control
Valuation Method	Used for EBITDA multiples (4×–8× range)	Common in valuing high-growth businesses
Deal Structuring	Drives purchase prices and earn-out terms	Plays a secondary role in negotiations
Standardization	Non-GAAP; varies in calculation	GAAP-compliant and consistent
Cash Flow Indication	Indicates cash generation	Shows income without cash conversion details

Industry Applications and Deal Structuring

The choice between EBITDA and revenue often depends on the industry and the company's growth stage. For example, EBITDA multiples are widely used in mature industries with stable cash flows, where operational efficiency is a key driver. In contrast, revenue multiples are more relevant for high-growth sectors, like tech startups, where future potential outweighs current profitability. A steady manufacturing company might sell at a 5× EBITDA multiple, while a fast-growing tech firm could command a revenue multiple exceeding 10×.

Margin quality also plays a big role in valuations. Companies with EBITDA margins above 20% tend to attract more attention from investors. Those exceeding industry averages may even see their EBITDA multiples rise by 1×–2× compared to peers. This is because buyers are essentially investing in an income stream, and efficient conversion of sales into earnings adds significant value.

When structuring deals, EBITDA is often the go-to metric. Buyers use it to calculate purchase prices, factoring in industry norms, growth prospects, and risk profiles. Earn-out provisions, which tie future payments to performance, are frequently based on EBITDA. Lenders also rely on EBITDA to assess a company's ability to manage debt. Revenue, while important for understanding market presence and growth trends, typically plays a secondary role in these negotiations.

The Role of EBITDA Addbacks

EBITDA’s flexibility extends to "addbacks", which allow sellers to adjust for one-time expenses, owner compensation, and other non-recurring items. These adjustments help normalize earnings, providing buyers with a clearer view of the company’s true earning potential under new ownership. On average, documented addbacks account for 53% of reported EBITDA. This level of customization isn’t possible with revenue figures, which remain static and don’t reflect operational improvements.

Conclusion

When it comes to business acquisitions, buyers tend to focus on EBITDA rather than revenue. Why? Because EBITDA reflects a company’s ability to generate consistent operational profitability - it’s a clear indicator of whether those sales translate into sustainable cash flow. While revenue shows the total sales figure, EBITDA dives deeper, revealing the true earning potential of the business.

This distinction highlights why buyers prioritize cash flow over raw sales. Private equity firms and strategic acquirers want to see how effectively a business turns its sales into earnings. EBITDA provides this insight by removing financial variables like taxes, interest, and depreciation, which can otherwise make comparisons between companies misleading.

For business owners planning to sell, boosting EBITDA is essential. Start by recasting your financials - add back one-time expenses, excessive owner compensation, and non-recurring costs. At the same time, focus on operational improvements: trim unnecessary expenses, renegotiate supplier contracts, and streamline processes. These efforts ensure your EBITDA aligns with industry standards and meets buyer expectations.

At the end of the day, buyers are looking for businesses that generate reliable cash flow. Companies with strong EBITDA margins and consistent operational performance are better positioned to attract serious buyers and command higher valuations. By understanding this preference and optimizing EBITDA, you can set your business up for a smoother sale and more favorable deal terms. It’s all about aligning your operations with what buyers value most.

FAQs

Why do buyers focus on EBITDA instead of revenue when evaluating a business?

Buyers tend to focus on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) rather than revenue because it provides a more accurate picture of a company's profitability and operational health. While revenue simply reflects the total income, EBITDA strips away non-operational elements like taxes and interest. This makes it easier to evaluate the business's core financial performance.

For buyers, EBITDA is a key tool in valuing businesses. It showcases how well a company can generate profit from its operations, without being influenced by financing methods or accounting practices. This focus allows buyers to compare companies across different industries and gauge their potential for growth and long-term success.

What steps can business owners take to increase EBITDA before selling their company?

To enhance EBITDA before selling your business, the key is to focus on boosting profitability and streamlining operations. Start by identifying and cutting unnecessary expenses. This could involve improving inventory management to avoid overstocking or waste and automating repetitive tasks to save time and reduce labor costs. Reviewing supplier contracts for better terms can also uncover hidden savings.

On the revenue side, explore opportunities to grow income. This might mean expanding into untapped markets, launching new products or services, or fine-tuning your pricing strategy to maximize returns. It’s also worth examining compensation structures, such as commissions and bonuses, to ensure they’re aligned with your profitability goals.

Taking these steps can help you showcase a stronger financial performance, making your business more appealing and potentially increasing its value to prospective buyers.

What are some drawbacks of using EBITDA in business valuations, and how can they be mitigated?

EBITDA has its shortcomings as a valuation tool because it overlooks several critical aspects, such as debt levels, taxes, shifts in working capital, and capital expenditures. This means it might not always provide a full and accurate picture of a company’s financial health.

To address these gaps, buyers and analysts often combine EBITDA with other metrics like cash flow or earnings before interest and taxes (EBIT). Making adjustments for one-time expenses, debt obligations, and capital investments can also refine the analysis, offering a clearer view of a company’s profitability and operational efficiency. By blending multiple metrics, buyers can gain a deeper understanding of a business’s actual value.