Sign inWhat is EBITDA and why does private equity use it?
EBITDA is earnings before interest, taxes, depreciation, and amortisation. It approximates operating cash generation before financing and accounting choices.
EBITDA = operating income + depreciation + amortisation
How practitioners use it
Private equity leans on EBITDA because it strips out the two things a sponsor intends to change: the capital structure and the tax position. What remains is closer to the operating engine being bought.
It is a proxy, not truth. EBITDA ignores capital expenditure, working capital swings, and cash taxes, all of which decide whether debt can actually be serviced.
This is why diligence spends so much effort on quality of earnings and on adjusted EBITDA. The adjustments are where deals are won and lost.
Worked example with round numbers
01
Operating income of 80 plus depreciation and amortisation of 20 gives EBITDA of 100.
02
At a 10.0x entry multiple that is an enterprise value of 1,000.
03
If 15 of the EBITDA is add-backs a buyer rejects, the same multiple implies 850 instead.
Where people get it wrong
- Accepting adjusted EBITDA without testing each add-back.
- Using EBITDA as a cash flow proxy in a capital-intensive business.
- Forgetting that leverage covenants usually reference a defined EBITDA, not the marketing figure.
Learn it by using it
Definitions stick once you have run the numbers yourself. The desk below is free and needs no signup.
Open the EBITDA multiple calculator