EBITDA Isn’t Everything: What Buyers Miss in Franchise Acquisitions

By Caitlyn Willett, National Franchise Sales

In the world of restaurant franchise acquisitions, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is one of the most scrutinized metrics. This measure of a restaurant’s cash flow offers buyers and sellers a way to compare businesses, regardless of their financing or tax structures. However, despite its importance, EBITDA is not the full picture. To explore why it’s so critical, I recently spoke with Michael Arrowsmith at National Franchise Sales to get his insights on why both buyers and sellers should pay close attention to this metric.

EBITDA essentially reflects the operational profitability of a business. It strips out factors like taxes, interest payments, and non-cash expenses such as depreciation, which helps provide a clearer view of how well a restaurant is performing on its own. For buyers, this means EBITDA can act as a valuable comparison tool between different restaurants, especially when tax structures or financing models differ. But, as Michael pointed out, while EBITDA can give a good sense of cash flow, it doesn’t account for capital expenditures, the necessary investments needed for things like new equipment, renovations, or maintenance. These costs are essential for the long-term health of a restaurant and can significantly impact profitability, but they don’t show up in the EBITDA calculation.

The real challenge with EBITDA comes in its limitations. It doesn’t tell you the whole story. For instance, while a high EBITDA might seem attractive, it might not reflect the actual operational costs needed to maintain or grow the business. In the case of franchises, there can be significant discrepancies between store-level EBITDA and corporate EBITDA, especially if certain expenses, like rent, are excluded from the store’s P&L. Without adjusting for these differences, a buyer may be misled by an inflated EBITDA figure that doesn't truly represent the cash flow the business generates after the sale.

This is why normalizing EBITDA is so important. By adjusting the calculation to account for one-time expenses or owner-specific costs (like rent if the owner owns the property), both buyers and sellers can arrive at a more accurate valuation of the business. Sellers often try to boost EBITDA by adding back personal expenses, but these adjustments should be carefully examined.

For buyers, EBITDA provides a starting point for understanding a restaurant’s ability to generate cash. A strong EBITDA signals that the business is healthy and profitable, with potential for sustained growth. However, it’s not the only metric that matters. Margins, the difference between revenue and the cost of goods sold (COGS), are also crucial. Strong margins indicate that the business is not only generating revenue but doing so efficiently. If margins are low, even a high EBITDA might be unsustainable in the long term.

In the end, whether you’re buying or selling, it’s important to have an experienced intermediary by your side. An intermediary brings knowledge of industry norms, helps both sides align their expectations, and ensures the process goes smoothly. By guiding both parties through the complexities of EBITDA and providing clarity on what’s truly important, an intermediary can make the difference between a successful transaction and a misstep that could delay or derail the deal.