Normalised EBITDA
Normalising EBITDA is not a matter of adding back everything that helps. It rebuilds the recurring profit the business can sustain under a new owner, and every adjustment needs evidence behind it.
What it is and why it exists
A buyer wants to know the profit the business can sustain under new ownership. That figure can differ from the EBITDA in your statutory accounts because of how the owners are paid, one-off items, rent paid to connected parties or the way costs are capitalised.
Normalising reconciles those differences to arrive at a recurring profit figure. An adjustment with evidence lets the buyer assess it. One without evidence is likely to be struck out, and it can trigger a wider review of your numbers.
+ personal expenses + excess pay to family members ± one-off items
± capitalised costs and recurring investment = normalised EBITDA
Adjustment 1: your remuneration compared with market
This is often the largest adjustment. The question is what it would cost to hire someone to do what you do, whatever you currently draw.
In UK owner-managed companies it frequently works against the seller. A common pattern is a director's salary around the personal allowance with the rest taken as dividends. Dividends are a distribution of profit, so they never reach the profit and loss account. If you draw £12,570 of salary and the business would need a managing director costing £95,000 a year including employer National Insurance at 15% and pension, normalised EBITDA goes down by the difference.
It can also work the other way. If the company pays you £180,000 of salary and the role is worth £95,000, EBITDA goes up by £85,000. Use the full employment cost, not just gross salary, and review every shareholder who works in the business. If there are three directors and the business needs one managing director and two operations managers, compare role by role.
Adjustment 2: rent on the premises
Very common in manufacturing, logistics and hospitality. The unit or shop belongs to you, your spouse or your pension scheme, often a SIPP or SSAS, and the rent the company pays is not a market rent.
If the company pays no rent, deduct from EBITDA the market rent a buyer will have to pay you or a third party. If it pays more than market, add back the difference. Rent paid to a pension scheme has to be on commercial terms anyway, so check that the lease reflects what the scheme is actually receiving.
If the property is valued separately, the business EBITDA must carry a market rent to avoid counting the value twice. Where the property will stay outside the sale, agree a market-rent lease before the process starts, reviewed by your solicitor and tax adviser, so the buyer sees the cost it will really bear.
Adjustment 3: personal expenses paid by the company
Cars used privately, travel with a holiday element, family health insurance, phones, utilities at a second home, meals. These are added back to EBITDA.
Only propose adjustments you can identify and support. A round number with no breakdown will be rejected in due diligence.
Be aware that this adjustment has a tax side. If personal costs were put through the company without being reported as benefits in kind on a P11D, or VAT was reclaimed on them, writing them up in an information memorandum documents the problem for the buyer. Speak to your tax adviser before anything goes in writing.
Adjustment 4: family members on the payroll
The adjustment is the difference between what is paid and the market cost of the role actually performed. If a family member earns £55,000 for an administrative role the market pays £28,000, the adjustment is £27,000, not £55,000.
If the family member has no real role, the full employment cost can be added back, but you will also need to explain the employment position, the timing and the cost of any change, including notice and the risk of an unfair dismissal claim.
Adjustment 5: one-off items
Anything that happened once and will not happen again. Added back if it was a cost, deducted if it was income.
- Redundancy and settlement payments from a one-off restructuring, added back.
- The cost of moving premises, a legal dispute or a systems implementation, added back.
- One-off grants, deducted.
- Profit on the sale of an asset, deducted.
- Clearly exceptional effects in one particular year, in whichever direction applies.
The test is whether it recurs, not how unpleasant it was. A customer dispute that comes round every two years is part of the business.
Adjustment 6: capitalised development and other capitalised costs
If the company develops software or its own products and capitalises part of the cost, reported EBITDA can rise without any extra cash coming in. How a buyer treats it depends on the nature of the asset, consistency in the accounting and, above all, how much recurring spend is needed to maintain the product and keep growing.
The whole amount is not always stripped out. Reconcile capitalised costs, amortisation, recurring investment and cash flow so that you and the buyer are looking at the same economics. This matters most in technology and engineering, and it also interacts with any R&D tax credit claims.
A worked example
An electrical and mechanical installation company with £2.1m of turnover, three director shareholders and a workshop owned by the directors' SSAS at a below-market rent.
| Item | Amount | Comment |
|---|---|---|
| EBITDA per accounts | £245,000 | From the statutory accounts for the last year |
| Directors' remuneration compared with market | - £30,000 | Salaries cost £120,000 including employer NI; a managing director and two contracts managers would cost £150,000 |
| Workshop rent | - £24,000 | The company pays the SSAS £12,000 a year; market rent is £36,000 |
| Personal expenses | + £22,000 | Two cars used privately and family health insurance |
| Family member in accounts | + £18,000 | Difference over the market cost of the role |
| One-off settlement payment | + £31,000 | Departure of the former contracts manager |
| Normalised EBITDA | £262,000 | 7% above the figure in the accounts |
The adjustments go both ways, which is exactly what a buyer expects to see. Had the directors presented only the three add-backs and ignored remuneration and rent, they would have shown £316,000. At a multiple of 4.2x, the £54,000 gap is worth £226,800 of enterprise value, and a buyer who finds it in due diligence will take it off the price and trust the rest of the numbers less.
Each line needs its evidence: payroll records, rent comparables or a surveyor's letter, invoices and the settlement agreement.
The evidence each adjustment needs
An adjustment without evidence is hard to defend. This is the minimum for each item:
- Remuneration. Payroll records and dividend vouchers for each director, the employer National Insurance and pension cost, and a salary benchmark for the equivalent role: a recruiter's view, a salary survey or the cost of a comparable manager in your area.
- Property. A surveyor's rental opinion or, at least, two or three dated comparables for similar units in the same area.
- Personal expenses. A list of invoices with amount, date and description. No list, no adjustment.
- Family members. Payroll records and an honest description of the role.
- One-off items. The document behind each one: settlement agreement, grant letter, completion statement for the asset sale.
Preparing this before you go to market lets you present a consistent series and answer quickly when the buyer tests each adjustment.
Frequently asked questions
Will the buyer accept all my adjustments?
Not necessarily. The buyer will check whether each item recurs, is correctly classified and is supported. Adjustments that are consistent with the track record and documented are easier to defend; those resting on estimates or verbal explanations usually get cut.
Can I normalise several years back?
Yes, you can normalise several years on a consistent basis to show the trend. The right period depends on the information available, how cyclical the business is and the metric the buyer uses. Each adjustment has to be applied the same way in every year.
What if normalising exposes a tax problem?
Talk to your tax adviser before you write anything down. Sometimes it makes sense to make a voluntary disclosure to HMRC before the sale process starts. The tax, accounting and valuation treatment need to line up so you do not give the buyer conflicting explanations.
