The Fallacy of EBITDA Multiples in Business Valuation

Valuing a business based on EBITDA multiples has become a common practice in the corporate world, but it is also one of the most misleading. As highlighted by Bradley Lay in a recent LinkedIn post, relying on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is fraught with inaccuracies. He quotes Charlie Munger, Warren Buffett’s legendary business partner, who famously said:

“Every time you see the word EBITDA, you should substitute the word ‘bulls**t earnings.’”

This article explores why EBITDA can be dangerously misleading and proposes practical alternatives for assessing a business’s true worth.

What’s Wrong With EBITDA?

EBITDA is often praised for its simplicity and ability to compare companies across industries. However, as Lay and Munger emphasize, it paints a distorted picture of a company’s financial health by ignoring critical costs:

  • Depreciation: Machinery, equipment, and other assets deteriorate and must be replaced—this is a real cost of doing business.
  • Tax Obligations: Taxes reduce cash flow and are unavoidable.
  • Real Debt Costs: Interest on loans and financing agreements are direct costs that cannot be ignored.
  • Equipment Replacement: Asset-heavy businesses require constant reinvestment, which EBITDA overlooks.

By removing these essential costs, EBITDA creates an illusion of profitability that can mislead buyers, investors, and even business owners themselves.

The Danger of Adjusted EBITDA

The use of “Adjusted EBITDA” compounds the problem. Adjusted EBITDA allows companies to exclude one-off expenses, restructuring costs, or any other items they deem non-recurring. While this may seem logical, it is often abused to inflate valuations by arbitrarily removing costs.

Bradley Lay describes this practice as “just making up numbers to suit their story.” Such manipulations can deceive stakeholders and create unrealistic expectations about the business’s financial performance.

The £14M Illusion

Bradley Lay shares a case study of a piling business owner who claimed his company was worth £14M, based on a £2M EBITDA and a 7x multiple. However, upon closer analysis, the company’s actual net profit before tax was just £500K. The business was asset-heavy, requiring regular reinvestments in machinery and financing agreements. In reality, the business’s value was closer to £1M, creating a shocking £13M “reality gap.”

This example highlights the dangers of relying solely on EBITDA multiples without considering real-world financial obligations.

A Practical Approach to Valuation

As Lay explains, your business is only worth what someone is willing to pay for it. A more accurate valuation method considers tangible metrics like net profit before tax, adjusted for assets and liabilities. Here’s a framework:

1. The Real Valuation

  • 1.5x to 3.5x Net Profit Before Tax: A reasonable multiple based on industry and growth potential.
  • Add: Net Assets: The value of machinery, property, and other tangible assets.
  • Subtract: Liabilities: Outstanding debts and financial obligations.
  • Add: Free Cash Flow: Cash available for reinvestment or distribution.

2. Factors That Determine the Multiple

  • Management Strength: A competent and experienced leadership team adds value.
  • Client Concentration: A diversified client base reduces risk.
  • Recurring Revenue: Predictable income streams are highly valuable.
  • Growth Potential: Businesses in expanding industries command higher multiples.

The Brutal Truth About Valuation

EBITDA and other fancy metrics might look impressive on paper, but they are only tools for initial analysis. Ultimately, the value of your business is determined by what someone is willing to pay for it.

Bradley Lay sums it up perfectly with this reminder:

  • Revenue is vanity
  • Adjusted EBITDA is fantasy
  • Net profit before tax is reality

A Call to Action

Business owners, investors, and buyers must move beyond superficial metrics like EBITDA and adopt valuation methods rooted in financial reality. By focusing on net profit, free cash flow, and tangible assets, you can avoid the pitfalls of inflated valuations and build a more sustainable business strategy.

References

  1. Lay, Bradley. (2025). LinkedIn Post: “EBITDA is a b*****t number, here’s why…”
  2. Lay, Bradley. Website
  3. Munger, Charlie. (n.d.). Criticisms of EBITDA. Various speeches and interviews.
  4. Damodaran, A. (2020). The Dark Side of Valuation: Valuing Young, Distressed, and Complex Businesses. Wiley.
  5. Kaplan, S. N., & Ruback, R. S. (1995). The Valuation of Cash Flow Forecasts: An Empirical Analysis. The Journal of Finance.
  6. Palepu, K. G., Healy, P. M., & Peek, E. (2016). Business Analysis and Valuation: IFRS Edition. Cengage Learning.

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