00:25:15 · Brian Neider
[00:25:15] S0: That is a really good, and I've gotta tell you a very, very difficult question to answer. So I have my own beliefs, which is you sort of wanna look at the EBITDA minus any legitimate add backs to get to some type of adjustment, and then you want to subtract out some of the capitalized expenditure... You know, capital expenditures to the extent that you think it's warranted. I do think that a lot of investors want to suspend disbelief to some regard, and it allows them to kind of jam things through their investment committees. So it's funny, like I've I've talked to friends who, you know, very large firms in many cases, when they talk about these businesses, it's like you spend a bunch of time talking about the merits of the business, but you're not really getting into the weeds on it. And what you're doing is you're relying on evaluation relative to an EBITDA multiple, but the EBITDA like isn't real. It's just sort of a made up number. And I think a lot of times, especially at firms where younger investors are trying to push things through, I think that it's often easier for them to like use a bigger number and it just looks better, it looks cheaper, it looks more reasonable. But to me, part of this is like, you know, you have to be reasonable about it. You have to understand and pick through all of the adjustments. You have to understand really where the cash is actually going. And that's the funny thing. You know? I I can't tell you how many companies we look at that are not actually levered because, you know, once a company's levered, then you've got situations where you have significant interest expenses, and you gotta really understand what's going on there underneath the EBITDA line. But I see a lot of companies that are not levered, and they had significantly positive EBITDA metrics for, like, years, but they've never produced a dollar of cash. Like, you look at the balance and it like never grows, and they've never issued a dividend. And so there's some of that... It's sort of like tied up or eaten up in working capital or whatever it might be. Over some period of time, it just... It's like wonky accounting, And you've got to say to yourself, like, what is actually going on here? And those are the most frustrating ones to me.
00:27:20 · Brian Neider, CJ Gustafson
So, ultimately, like, what we end up doing oftentimes to almost normalize it is we're looking at some type of EBITDA multiple in the way in which we might define it, which would include some light adjustments based upon things that we feel are reasonable, specifically calling those out. In many cases, I'm doing some type of EBITDA minus CapEx orientation. That's one. But at the same time, we're actually gonna look at the revenue multiple because a lot of these businesses, they look somewhat similar. You could get your arms around them. And if you're looking at both, that's a good thing to be doing. And what we see a lot of is, you know, people just throw out numbers. Oh, this should be valued at 20 times EBITDA. Okay. Well, like, that's great, but it's very different if the business is a 40% EBITDA margin business that's not growing versus a 20% EBITDA margin business that's growing 40% a year, is EBITDA even the right metric to be looking at? So we try to look at both revenue and EBITDA, and in some cases, even gross profit just to get our orientation or bearings about us. [00:28:20] S1: How do you decide if a company trades off a revenue multiple versus an EBITDA multiple?
00:28:20 · CJ Gustafson, Brian Neider
[00:28:20] S1: How do you decide if a company trades off a revenue multiple versus an EBITDA multiple? [00:28:25] S0: Early on, you know, for a lot of the business that we look at, which might be, you know, software or AI, when they're younger, usually they're going to trade on a revenue multiple, more likely because they don't have profits to begin with, and in many cases, they're growing very fast, and so it's the only way to normalize things. I think that as you get into that mid stage where there's like a healthy dose of both profitability and growth, it's really, really important to look at both metrics. Once you get to the very late stage when a company is much later in its life cycle, growing slower, maxed out its margin profile to some degree, at that point, probably it's most appropriate to look at it on on on EBITDA or profitability metric multiple. It's not a hard and fast rule, but that's generally generally how it'll work out. [00:29:09] S1: My rough mental framework is if a company's over a $100,000,000 in revenue and they have profitability, if you're growing at more than 30% year on year, you have the right to to trade at a revenue multiple. But if you're growing at say 20%, 15%, it's like, hey dude, you're not gonna be able to grow fast enough to outrun the cost structure you're presenting today. That's probably more indicative of an EBITDA multiple. [00:29:29] S0: I think that's a good framing. [00:29:30] S1: What's the craziest EBITDA add back you've ever seen?
00:29:30 · CJ Gustafson, Brian Neider
[00:29:30] S1: What's the craziest EBITDA add back you've ever seen? [00:29:33] S0: There's been a lot of them, especially when you get into, you know, bootstrap founder led businesses. [00:29:40] S1: Like the owner's boat, a horse trailer. [00:29:42] S0: There's a lot of stuff. Those things are crazy, but in actuality, they're probably pretty reasonable add backs. The ones that are the hardest to kind of swallow are recurring expenses that the company is gonna add back and argue that it's more of a one time thing. So I've seen situations as an example where a company will say, well, we had an inordinate amount of of hiring this year, and so we're adding back, you know, recruiting fees and recruiting expenses because we had a lot of headhunters that we were using. Well, you know, like, you kind of, like, expect that every year, and you might have... As you get bigger, you're gonna have more turnover, which means you're gonna need to use more recruiters or hire more people on the HR side, and that that makes it difficult. And so when you have things that really are recurring, but you're adding them back, that's tough. I think that you really have to substantiate whether or not it's one time and whether or not it's ordinary course. [00:30:30] S1: I bet you look at a lot of companies whose modus operandi is doing M and A, but then they add back the legal expenses and M and A expenses. What do you think?
00:30:30 · CJ Gustafson, Brian Neider
[00:30:30] S1: I bet you look at a lot of companies whose modus operandi is doing M and A, but then they add back the legal expenses and M and A expenses. What do you think? [00:30:41] S0: That is a devil in a detail type question. Because if that is the only path for their growth, then you have a situation where, yeah, maybe it's okay to add it back in certain circumstances, but it's going to persist as you continue to bring on new, you know, new m and a targets and and execute on your plan, so it becomes more like a recurring cost. It really depends. It's... That's that's a hard one to answer without understanding other dynamics in the business in terms of how recurring it is and what what the actual margin profile looks like. It's it's difficult. [00:31:11] S1: Anything else on EBITDA that just makes the the hair on your arm stand up?
00:31:11 · CJ Gustafson, Brian Neider
[00:31:11] S1: Anything else on EBITDA that just makes the the hair on your arm stand up? [00:31:15] S0: A lot of it just has to do with the recurrence versus non recurrence. Like, don't actually mind... If if there's some Bootstrap CEO that put their boat expenses in there, it's probably not the right place to put it, but the reality of situation is when we take over the business or when we invest into the business, that's not gonna happen anymore. So it's actually somewhat legitimate. If you have expenses for... You know, there's a frivolous lawsuit that you had and it happened one time and you had to deal with a bunch of legal fees. Like, sure. That type of stuff feels like very, very reasonable and no problem. It's just things that are recurring, nonrecurring. It's not the same exact thing that happens every year, but it's roughly like it rhymes with each other, and you just see it over and over and over again. That's where it's just like, guys, there's... This just makes no sense.