For tech founders, navigating the world of financial metrics can feel overwhelming. There are so many metrics for tech companies out there, and it can be difficult to know which to prioritize. One unquestionably important metric is adjusted EBITDA. Your company’s adjusted EBITDA often becomes a focal point during fundraising rounds, board meetings, and exit discussions, yet many founders struggle to understand how to appropriately define it for their businesses.
When used correctly, adjusted EBITDA provides a clearer picture of your company's underlying operational performance by removing the noise of one-time expenses and non-cash charges that can obscure your business's true earning potential. However, when misused or manipulated, it can damage your credibility with sophisticated investors who know what to look for.
In this overview, we’ll explain what adjusted EBITDA is, why it matters for tech companies, and how to calculate it in a way that builds rather than erodes investor confidence. Most importantly, we'll show you how to use this metric as a tool for better decision-making and more effective communication with stakeholders.
What is Adjusted EBITDA and Why Does It Matter?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It's designed to show a company's operating performance by removing the effects of financing decisions (interest), tax environments (taxes), and accounting decisions around asset investments (depreciation and amortization).
For tech companies, EBITDA provides a useful baseline because it strips away many of the variables that can make it difficult to compare operational performance across different companies or time periods. However, even EBITDA doesn't tell the complete story for many tech businesses.
The Logic Behind Adjustments
Adjusted EBITDA takes the concept one step further by removing additional items that may not reflect the ongoing, sustainable performance of your business. The goal is to show what your company's earnings would look like in a "normalized" operating environment, without the impact of one-time expenses, non-cash charges, or unusual events.
Think of it this way: if an investor is trying to value your company based on its future earning potential, they need to understand what your business looks like when it's running at steady state, not during periods of exceptional costs or unusual circumstances.
Why Tech Companies Use Adjusted EBITDA
Technology businesses often face unique financial circumstances that can make standard EBITDA less representative of operational performance. Tech companies frequently incur significant one-time expenses, ranging from legal fees related to intellectual property disputes, to costs associated with major product launches, to expenses related to fundraising or acquisition activities.
Additionally, many tech companies use substantial stock-based compensation to attract and retain talent. While this represents real economic value transferred to employees, it doesn't require cash outlay, making it different from traditional salary expenses. These factors can make adjusted EBITDA particularly relevant for tech companies seeking to communicate their operational performance clearly.
Investor Perspective
Sophisticated investors understand that both GAAP metrics and adjusted metrics serve different purposes. GAAP financial statements provide the legal and regulatory view of your business, while adjusted metrics can provide insight into operational trends and future potential. The key is using both transparently and appropriately.
Investors aren't looking for companies to manipulate their numbers: they're looking for companies that can clearly communicate their operational performance and demonstrate sustainable business models. When adjusted EBITDA is calculated thoughtfully and presented transparently, it becomes a valuable tool for this communication.
Common Adjustments for Tech Companies
Understanding what types of adjustments are commonly accepted (and which ones raise red flags) is crucial for maintaining credibility with investors and acquirers. Below, we’ve outlined some of the most common adjustments we see technology companies make.
Stock-Based Compensation
A common adjustment for tech companies is adding back stock-based compensation expense. Although it reflects the value of equity granted to employees, it's a non-cash charge that doesn't impact the company’s immediate cash flow.
However, it's important to acknowledge that stock-based compensation represents real economic cost since you are transferring ownership value to employees. Many sophisticated investors will scrutinize this adjustment closely, particularly if stock-based compensation represents a large percentage of total compensation or if it's growing significantly over time.
One-Time Expenses
One-time expenses are large expenses that you do not reasonably expect to recur in the future. Legitimate one-time expenses that might be adjusted include:
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- Legal fees related to major litigation, patent disputes, or regulatory investigations
- Restructuring costs associated with layoffs or organizational changes
- Acquisition-related expenses, including legal fees, due diligence costs, and integration expenses
- Costs associated with major fundraising rounds or preparation for public offerings
The key test for these adjustments is whether the expense is truly non-recurring. If you're adding back "one-time" legal fees every quarter, investors will quickly recognize that legal expenses may be a recurring part of your business model.
Non-Recurring Items
Sometimes businesses experience unusual gains or losses that don't reflect ongoing operations. For example, if you sold a piece of equipment or settled a legal dispute for a significant amount, these items might be adjusted to show what your business performance looks like without these exceptional events.
The guiding principle here is that adjusted EBITDA should reflect what an investor might expect from your business on an ongoing basis, not what happened due to unusual circumstances.
Non-Cash Impairments
If your company has had to write down the value of intangible assets, goodwill, or other investments, these non-cash charges might be appropriate to add back in calculating adjusted EBITDA. However, frequent impairments might indicate deeper issues with asset valuation or business performance that investors will want to understand.
How to Calculate Adjusted EBITDA
Calculating adjusted EBITDA requires a systematic approach that ensures accuracy and maintains credibility with stakeholders.
Start with Net Income
Begin with your GAAP net income from your income statement. This provides the foundation for all subsequent calculations and ensures you're working from high-quality financial information.
Add Back Standard Items
Next, add back the standard EBITDA items:
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- Interest expense (and subtract interest income)
- Tax expense
- Depreciation expense
- Amortization expense
This gives you your basic EBITDA figure. Next, it’s time to adjust that figure.
Apply Adjustments
Now add back the specific items you've identified as appropriate adjustments for your business. Each adjustment should be:
Clearly defined and documented
- Supported by underlying accounting records
- Consistent with adjustments made in prior periods
- Defensible to investors and auditors
Document Everything
Maintain detailed documentation for each adjustment, including:
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- The specific nature of the expense or income being adjusted
- The business rationale for the adjustment
- Supporting documentation from your accounting records
- Explanation of why the item is considered non-recurring or non-cash
Example Adjusted EBITDA Calculation
Consider a hypothetical SaaS company with the following financial profile during a reporting period:
Net Income: $500,000
Interest Expense: $50,000
Tax Expense: $100,000
Depreciation: $75,000
Amortization: $25,000
EBITDA = $750,000
Stock-Based Compensation: $200,000
One-Time Legal Fees: $100,000
Restructuring Costs: $50,000
Adjusted EBITDA: $1,100,000
In this example, the company's adjusted EBITDA of $1.1 million provides a much different view of operational performance than the net income of $500,000, primarily due to significant stock-based compensation and one-time expenses during the reporting period. It’s important, as explained above, that each of these adjustments is fully documented and defensible.
Best Practices and Red Flags
Understanding what makes adjusted EBITDA calculations credible and what raises investor concerns is crucial for maintaining stakeholder trust. Below is a list of key factors that founders and executives should keep in mind when calculating adjusted EBITDA for their business.
Investor Credibility
Excessive or questionable adjustments can quickly damage your credibility with investors. If your adjusted EBITDA is dramatically higher than your GAAP net income, be prepared to explain every adjustment in detail.
Investors have seen companies try to "adjust away" their problems, and they're skilled at identifying when adjustments cross the line from legitimate to manipulative. The most famous example of this was WeWork’s infamous “community adjusted EBITDA”, which stripped out marketing, general, and administrative costs, and contributed to widespread investor skepticism before an IPO that ultimately collapsed.
Consistency
Apply adjustments consistently across time periods. If you add back stock-based compensation in one quarter, you should do so in all comparable periods. Changing your adjustment methodology between periods without clear explanation will raise questions about the reliability of your financial reporting.
Quality Matters
Focus on the quality of your adjustments, not just the quantity. A few well-documented, clearly legitimate adjustments will be more credible than numerous small adjustments that individually might seem reasonable but collectively suggest you're trying to manipulate your numbers.
Distinguish between legitimate one-time items and recurring operational issues. For example, if you're consistently adding back "customer implementation costs" every quarter, investors might conclude that these are recurring costs of doing business, not one-time expenses, and therefore should not be included in your adjusted EBITDA figure.
Common Pitfalls
Avoiding common mistakes is essential when calculating adjusted EBITDA. One frequent error is adding back regular business expenses simply because they’re large, even though they’re part of normal operations. Another is labeling recurring operational challenges as “one-time” items, which can misrepresent the company's financial health.
Some companies make adjustments without proper documentation or fail to clearly explain their reasoning to investors, both of which can erode trust. Worst of all is using adjusted EBITDA to obscure deeper business problems, which not only misleads stakeholders but can also backfire during due diligence ahead of a potential exit.
Using Adjusted EBITDA Effectively
When calculated and presented appropriately, adjusted EBITDA becomes a powerful tool for communicating with various stakeholders.
Fundraising
During fundraising, investors often use adjusted EBITDA as one factor in valuation discussions. They're looking for evidence that your business can generate consistent cash flow and that current performance issues are temporary rather than structural.
Be prepared to walk investors through each adjustment and explain why it's appropriate. The best approach is to present both GAAP metrics and adjusted metrics side-by-side, with clear explanations of the differences.
M&A Transactions
In merger and acquisition discussions, adjusted EBITDA often plays a central role in purchase price calculations. Buyers want to understand what they're acquiring in terms of ongoing earning potential, separate from one-time transition costs or historical issues.
Quality of earnings studies conducted during due diligence will scrutinize every adjustment, so maintaining detailed documentation and conservative adjustment practices pays dividends during exit processes.
Board Reporting
For board meetings, adjusted EBITDA can help communicate operational performance trends separate from accounting noise. Board members often find adjusted metrics helpful for understanding underlying business momentum.
However, always present adjusted metrics alongside GAAP metrics, and be transparent about the adjustments you're making. Board members are fiduciaries who need to understand both the financial position and the operational performance of the business.
Related: Five Board Reporting Requirements First-Time Founders Need to Know
Build Credible Financial Reporting with G-Squared Partners
Adjusted EBITDA is a valuable tool when used appropriately and transparently. It can provide crucial insights into your company's operational performance and help communicate your business's potential to investors and other stakeholders. However, the key to success lies in calculating it correctly, documenting it thoroughly, and presenting it honestly.
The foundation of credible adjusted EBITDA calculations is strong underlying financial reporting. Without accurate GAAP financial statements, clean accounting records, and proper documentation, even the most legitimate adjustments can appear questionable to sophisticated investors.
At G-Squared Partners, we specialize in helping tech companies build robust financial reporting frameworks that support both compliance and strategic communication. Our fractional CFO services include establishing proper financial reporting processes, developing credible adjusted metrics, and preparing companies for investor and acquirer scrutiny.
Whether you're preparing for your next fundraising round, considering an exit, or simply want to improve your financial reporting, we bring the expertise and experience to help you present your numbers with confidence.
Ready to ensure your financial metrics tell the right story? Contact G-Squared Partners today to learn how our fractional CFO services can help you build investor-ready financial reporting that supports your growth objectives.
