Where Do You Stand on “EBITDAC”

and “Voodoo” Economic Forecasts?

One of the issues facing the business valuation community as well as business owners is the newly created accounting metric called “EBITDAC”, which stands for Earnings Before Interests, Taxes, Depreciation, Amortization, and Coronavirus. This is a non-GAAP accounting metric used by some companies today to raise more debts from lending institutions by adjusting or recasting their financial statements to account for lost earnings incurred due to the coronavirus. The author asks what coronavirus add-backs are defensible under this new normal?

One of the issues facing the business valuation community as well as business owners is the newly created accounting metric called “EBITDAC”, which stands for Earnings Before Interests, Taxes, Depreciation, Amortization, and Coronavirus. This is a non-GAAP accounting metric used by some companies today to raise more debts from lending institutions by adjusting or recasting their financial statements to account for lost earnings incurred due to the coronavirus.

Many professionals believe it makes sense to add back those “potential” earnings due to this unique non-recurring or extraordinary event that is the pandemic, and others call for caution and advise not to go that route that could lead to potential issues that may not be fully understood at this point by all the stakeholders using this new accounting metric. Essentially, the main issue here is, for those who believe in using that new metric, how to determine that lost earnings attributable to the coronavirus.

We know that the pandemic is still ongoing in many parts of the world and we have no idea when it will “disappear”, in fact, the World Health Organization (WHO) and China are even talking about a second wave that could be as devastating as the first if not more. We also know that business valuation is future-oriented with a future right now that is bleak or very uncertain, to be more prudent. How can we recast, adjust, or create projections or forecasts that are defensible without them being referred to as voodoo^[1] economics?

What is EBITDA?

It is an accounting principle that is vital for every business owner to understand post-pandemic. EBITDA is the metric that mergers and acquisition professionals use to recast or normalize the financial statements of a company by removing items that are not part of the normal operations of the business under new ownership. Some of those items include:

• Losses due to fire
• Losses due to employee embezzlement
• Other business disruptions beyond your control (floods, earthquakes, tsunamis)
• Cars, planes, and boats being expensed through the business for your personal use
• Inactive family members on the payroll
• Compensation for active family members on the payroll who were being paid well above fair market
• Any of your compensation that was below or above fair market value
• Memberships at country clubs, yacht clubs, and gyms for your personal use
• Travel and vacations for you and your family that the company expensed

But now to this list, you may be able to add loss of revenue and income due to the impact of the “C” (coronavirus). However, when analyzing the impact of coronavirus add-backs, we see that the business earnings may be significantly increased, though difficult to explain, support, or defend. Keep in mind that those add-backs are “expected” or “estimated” earnings that never occurred.

How to Determine the “C” in EBITDAC?

This is where the trouble lies in adding back “estimated” losses due to coronavirus on EBITDA. Many business valuation experts consider this as a one-time, extraordinary, or non-recurring event. Others think the event is still ongoing and cannot be considered “yet” a one time, or non-recurring event because there is still the possibility that it impacts businesses beyond one quarter and even two or three quarters. Nothing is clear at this point. Therefore, the use of this metric is unwarranted and may lead to unexpected consequences if the value of the company is overstated, particularly in a tax valuation.

Depending on the importance of the add-back, there is the possibility the experts’ exposure to liabilities from the IRS, the client, or other stakeholders of the valuation report like lending institutions, investors, shareholders, and others, may be greatly enhanced because of the difficulty to defend the use of a fictitious metric that has never been used before in a valuation. Many investors and regulators are against using that metric that will distort (reduce) the leverage ratio of a company and allow it to raise more debts than they can handle.

Still, some believe that by analyzing the trailing 12 months EBITDA, and other historical performance data, they can determine with a “reasonable degree of certainty” what those coronavirus add-backs should be. But that could be problematic if the pandemic persists longer than expected and becomes a “new normal”.

Conclusion

Whether you stand for or against the use of the coronavirus add back, one fact that remains certain is that a great number of experts, investors, accounting firms, federal agencies like the SEC, the European Leveraged Finance Association (ELFA) that represents investors in higher-risk corporate bonds and loans, are prohibiting the use of coronavirus add-backs. According to them, reliance on fictitious figures could lead to a downward spiral of companies raising money that they cannot repay. If this happens, many of those companies may default on their loans and declare bankruptcy and/or go out of business completely to the detriment of many stakeholders.

This article was previously published on the author’s blog site at www.washingtonvaluation.com/blog.

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^[1] Voodoo economics: an economic policy perceived as being unrealistic and ill-advised; a policy of maintaining or increasing levels of public spending while reducing taxation.

Achille Ekeu is the President and CEO of the Washington Valuation Group, LLC and currently serves on the Valuation Credentialing Board (VCB) of the National Association of Certified Valuators and Analysts (NACVA). He is also the State Chapter President of NACVA for Maryland and Washington DC. Mr. Ekeu is the Author of a book titled 30 Frequently Asked Questions in Business Valuation. He focuses on business valuation for tax and transaction purposes. 

Mr. Ekeu can be contacted at (240) 274-9570 or by e-mail to achille.ekeu@washingtonvaluation.com.