Adjusted EBITDA

Full Definition

Adjusted EBITDA is the metric on which M&A transactions, credit agreements, and management compensation plans are actually based. Starting from reported EBITDA, analysts add back items that are genuinely non-recurring—restructuring charges, transaction costs, above-market founder compensation, one-time litigation settlements—and non-cash items like stock-based compensation. The objective is to isolate the earnings power a new owner would realistically expect on a go-forward basis, uncontaminated by historical anomalies or owner-specific expenses. The legitimacy of each add-back is the central battleground in M&A diligence. Sellers frequently attempt to add back items that are not truly one-time: perpetual legal costs labeled as a single event, above-market compensation replaced by a lower salary that never materializes, or technology investments that are simply part of running the business. Quality of Earnings reports from sell-side accounting firms typically support aggressive positions, while buy-side advisors challenge each add-back with supporting documentation requirements. In PE-backed companies, credit agreements specifically define Adjusted EBITDA, enumerating permitted add-back categories and caps. Add-backs exceeding 25–30% of reported EBITDA are a significant red flag and warrant deep investigation. Best practice calls for presenting a clean waterfall from GAAP net income through every adjustment line, with supporting documentation for each item—invoices for one-time expenses, HR agreements for compensation normalization, board minutes for non-recurring decisions. Buyers who accept seller-prepared add-backs without independent verification routinely discover post-close EBITDA shortfalls that erode returns and create lender covenant stress.

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