EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is the most commonly used financial metric in private equity for valuing companies, structuring transactions, and measuring operating performance. When someone in PE says a company “does $10M,” they almost always mean $10M in EBITDA.
The calculation starts with net income and adds back four items: interest expense (a function of capital structure, not operations), income taxes (variable based on jurisdiction and strategy), depreciation (a non-cash charge on physical assets), and amortization (a non-cash charge on intangible assets). What remains is a rough approximation of the cash the business generates from its core operations before financing and accounting decisions.
In practice, the EBITDA number that matters in a PE transaction is almost never the raw figure. It is adjusted EBITDA, which strips out additional items that are non-recurring, non-operational, or above-market. Common adjustments include excess owner compensation (a founder paying themselves $500K when a hired CEO would cost $300K), one-time legal or consulting fees, facility relocation costs, and revenue or expenses related to discontinued product lines. The quality of earnings (QoE) report, prepared by an independent accounting firm during diligence, pressure-tests every adjustment. The gap between management’s adjusted EBITDA and the QoE-confirmed EBITDA is where many deals get repriced or die.
EBITDA is the denominator in the most important equation in PE: enterprise value divided by EBITDA equals the valuation multiple. If a company is acquired at 8x EBITDA and does $10M in adjusted EBITDA, the enterprise value is $80M. If the PE firm grows EBITDA to $15M over the hold period and sells at 9x, the exit enterprise value is $135M. This simple math drives the entire return framework of a leveraged buyout.
EBITDA also drives debt capacity. Lenders size their commitments as a multiple of EBITDA. A 4x leverage ratio on $10M of EBITDA means $40M of available debt. Covenants are often expressed in EBITDA terms: maximum total leverage of 5.0x EBITDA, minimum interest coverage of 2.0x EBITDA. Every dollar of EBITDA growth increases both the company’s equity value and its debt capacity.
For fund managers, EBITDA is the language of portfolio reporting and LP communication. Quarterly reports to limited partners will track EBITDA growth across portfolio companies as a core performance metric. The narrative around each investment is fundamentally an EBITDA story: what the EBITDA was at entry, what it is today, and what the plan is to grow it through exit. When you present to your LP advisory committee, that is the number they will ask about first.
Frequently Asked Questions
What is the difference between EBITDA and adjusted EBITDA?
EBITDA starts with net income and adds back interest, taxes, depreciation, and amortization. Adjusted EBITDA goes further by removing one-time, non-recurring, or non-operational items like owner compensation above market rate, litigation costs, one-time professional fees, or the cost of a facility move. In PE transactions, adjusted EBITDA is almost always the basis for valuation. The adjustments, and their defensibility, are one of the most negotiated aspects of any deal.
Why is EBITDA used instead of net income in private equity?
Net income is affected by capital structure (interest expense), tax strategies, and accounting choices around depreciation. These all change the moment a PE firm acquires the business. EBITDA strips out those variables and provides a cleaner view of the company's core operating profitability, making it easier to compare companies across different capital structures and tax situations.
What is a good EBITDA margin?
EBITDA margins vary significantly by industry. Software companies often run 30-50% EBITDA margins. Professional services firms typically fall in the 15-25% range. Manufacturing businesses might operate at 10-20%. Distribution companies often run 5-10%. There is no universal 'good' margin. What matters is how the company's margin compares to its direct peers and whether there is a credible path to margin expansion.
