Should you avoid business debt? Not necessarily, and in some cases, debt has little or no bearing on a business’s earnings and worth. Debt’s importance and meaning depends on how and for what purpose, a valuator determines a company’s worth.


Does no debt mean additional value? Actually, lacking debt may be meaningless to potential buyers because, as one valuator says, buyers look for “gross value, which is a function of earnings and what the marketplace is willing to pay for those earnings.” But debt can be problematic in some situations. Let’s take a closer look at the effects of debt on business evaluation.


Distinguishing the good from the bad

Just as operating a business with no or low debt can negatively affect its value, carrying heavy debt may be unnecessary and could prove costly. In fact, debt may force an entrepreneur to provide personal guarantees or take out a home equity line of credit to support his or her business.


Understanding EBITDA

Whether the business is in the service, manufacturing or distribution industries, valuators will generally focus on its income and cash flow. In addition, valuators are increasingly examining earnings before interest, taxes, depreciation and amortisation (EBITDA) in determining a company’s value – especially if the company has little or no earnings..


In EBITDA, debt – which takes the form of interest – is not subtracted from the company’s value. This approach is somewhat similar to a cash flow approach. EBITDA can gauge a company’s value when it’s taking on debt to fuel expansion in a high-growth industry. Companies in industries such as telecommunications and cable television use debt to build costly networks from which they hope to reap future profits.


Using EBITDA as a value indicator requires valuators to closely study the earnings capacity rather than blindly accept it. Why? Because companies often use EBITDA to put a positive spin on questionable earnings or poor cash flows.


Taking it case-by-case

Because debt can affect businesses in various ways, valuation analysts must consider each valuation on a case-by-case basis.