What Is Adjusted EBITDA?
Adjusted EBITDA starts with earnings before interest, taxes, depreciation, and amortization, then layers on additional addbacks intended to show the normalized cash-generating power of the business. Typical adjustments include restructuring and severance costs, stock-based compensation, litigation settlements, M&A transaction fees, and pro forma cost savings from recent acquisitions. The goal is a run-rate figure that a buyer or lender can multiply with confidence.
Because it is a non-GAAP measure, there is no single authoritative definition. A company's earnings release, its credit agreement, a lender presentation, and a sell-side banker's marketing materials can each define adjusted EBITDA differently for the same business. Anyone using the number needs to read the footnotes and reconciliation before comparing it across companies.
How It Is Calculated
The build is mechanical: take net income, add back interest expense, taxes, depreciation, and amortization to reach EBITDA, then add each agreed adjustment. Suppose a company reports $100 million of EBITDA that includes $15 million of restructuring charges and $10 million of stock-based compensation. Adding both back produces $125 million of adjusted EBITDA. At an 8x valuation multiple, those addbacks alone swing implied enterprise value by $200 million.
In credit agreements, the definition runs for pages because covenant compliance depends on it. Leverage covenants are usually tested as net debt divided by adjusted EBITDA, so borrowers negotiate for generous addbacks, including projected synergies and anticipated cost savings, often subject to a cap such as 20% to 25% of total EBITDA. A looser definition effectively grants more debt capacity.
Why It Matters in Deals
Private equity deals live and die on this number. Purchase prices are quoted as multiples of adjusted EBITDA and debt packages are sized against it, while management earnouts and incentive plans are frequently tied to hitting adjusted EBITDA targets. During diligence, quality of earnings providers rebuild the metric line by line, and disagreements over a few million dollars of addbacks translate directly into purchase price at the deal multiple.
The metric's weakness is that aggressive addbacks can dress up a mediocre business. Recurring restructuring charges, uncollected synergies, optimistic run-rate assumptions, and pro forma savings that never materialize have burned plenty of lenders and buyers. A useful sanity check is comparing adjusted EBITDA to actual free cash flow over several years; a chronic shortfall means the adjustments are masking real economic costs.
