What is adjusted EBITDA? Definition, formula and example
This is for anyone who has seen "adjusted EBITDA" at the top of a deal memo and wondered what was adjusted. By the end you will know the two kinds of adjustment, how to check each one, and why the adjusted figure can be higher or lower than plain EBITDA.
What adjusted EBITDA means in plain words
EBITDA is net income with interest, taxes, depreciation and amortization added back. Adjusted EBITDA goes one step further. It tries to show what the business would earn in a normal year under a new owner who pays market rates for everything.
Two things change. Costs that will not repeat, or that belong to the seller personally, are added back. Costs the seller was under-paying are raised to market. The second step is the one sellers forget, and the one buyers and lenders look for first.
The adjusted EBITDA formula
Adjusted EBITDA = EBITDA + add-backs − normalisations
Add-backs (they raise the figure) are one-time, non-recurring or owner-related costs: a lawsuit settlement, a flood repair, the owner's personal car, a relative on payroll who does not work there. Each needs a document. The full test is in our post on add-backs.
Normalisations (they usually lower the figure) fix costs that are not at market: an owner who pays themselves $40,000 for a $120,000 job, rent of $1 paid to a building the owner also owns, a key employee who is under-paid and will leave. Investopedia's EBITDA explainer covers the add-back side; the normalisation side is what a quality of earnings review tests.
A worked example
Illustrative example: a $6M-revenue marketing agency whose owner also owns the office building.
| Line | Amount | Direction |
|---|---|---|
| Reported EBITDA | $900,000 | Starting point |
| Add back: one-time legal settlement | +$60,000 | Non-recurring, invoice on file |
| Add back: owner's personal travel | +$25,000 | Card statements on file |
| Normalise: owner's salary $50,000 → market $150,000 | −$100,000 | A CEO must be paid |
| Normalise: rent $60,000 → market $120,000 | −$60,000 | Related-party lease |
| Adjusted EBITDA | $825,000 | Lower than reported |
At 5 times, the seller's $900,000 figure implies a $4,500,000 price. The adjusted $825,000 implies $4,125,000. That $375,000 gap is why the normalisation step matters, and why it is often argued over.
Where adjusted EBITDA shows up in a deal
Sellers present it in the CIM, and a good sale process prepares every adjustment with proof before the listing goes out. Buyers rebuild it during diligence, often with a quality of earnings report. Lenders use their own version: an SBA lender working under the 7(a) program will accept documented add-backs and will insist on a market salary for the operator.
In a roll-up, adjusted EBITDA is the number each add-on is priced on and the number the combined group is later valued on. Small errors repeated across ten acquisitions become a large one. Public companies that report adjusted EBITDA must reconcile it to net income under the SEC's rules on non-GAAP measures; private sellers face no rule, so the buyer is the only check.
Common mistakes
- Add-backs without normalisations. A list that only goes up is a sales document, not an earnings figure.
- "One-time" costs that happen every year. A bad-debt write-off in each of three years is a cost of doing business.
- No market salary. If the owner works 60 hours a week for $40,000, the buyer must budget for a real manager.
- Related-party rent left at the old rate. Ask what a stranger would charge for the same space, and use that.
- Growth counted as an adjustment. Next year's expected revenue is a forecast, not an add-back.
Questions people ask
Is adjusted EBITDA higher or lower than EBITDA?
It can be either. Add-backs raise it and normalisations lower it. A seller's version is usually higher; a buyer's or lender's version is often lower once market salary and rent are applied.
What counts as a normalisation?
Any cost the seller pays above or below market: an owner's salary, rent to a related party, a family member paid for no work, or an under-paid key employee. The figure is moved to what a new owner would really pay.
Who decides which adjustments are allowed?
The buyer and the lender decide what they will pay for. A quality of earnings report, done by an outside accountant, is the usual way to settle a dispute over the adjustments.
Why do lenders care about adjusted EBITDA?
The loan is repaid from future cash, so the lender wants the figure a new owner will really see. Lenders accept documented one-time costs and reject adjustments that depend on the seller staying in the business for free.
Sources
- investopedia.com — https://www.investopedia.com/terms/e/ebitda.asp
- investor.gov — https://www.investor.gov/introduction-investing/investing-basics/glossary/non-gaap-financial-measures
- sba.gov — https://www.sba.gov/funding-programs/loans/7a-loans
Pober, M. (2026). What is adjusted EBITDA? Definition, formula and example. Acquisitions.com. https://acquisitions.com/blog/what-is-adjusted-ebitda/
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