Stock-based compensation is included in standard EBITDA but excluded from Adjusted EBITDA. Because accounting rules treat SBC as an operating expense, it sits inside the earnings figure that standard EBITDA starts from and never gets added back alongside interest, taxes, depreciation, and amortization. Most companies, especially in technology, then publish a second figure called Adjusted EBITDA that reverses the SBC expense on the theory that no cash left the building. Both numbers are legitimate. They answer different questions, and the gap between them can be large enough to change what a company is worth.
Why Standard EBITDA Keeps SBC as an Expense
Under ASC 718, companies measure the fair value of stock options, restricted stock units, and similar awards on the grant date and recognize that cost as an expense over the period the employee earns it. The expense lands on the income statement, usually inside research and development or selling, general, and administrative costs. For companies with manufacturing operations, some SBC tied to production employees is capitalized into inventory and eventually flows through cost of goods sold.
Standard EBITDA starts with net income and adds back four items only: interest, taxes, depreciation, and amortization. SBC is none of those, so it stays subtracted. If a company spent $200 million on equity grants during the year, that $200 million weighs on standard EBITDA the same way cash salaries would.
Why Adjusted EBITDA Strips It Out
Many management teams report Adjusted EBITDA, which takes the standard calculation and reverses the SBC expense. The reasoning is simple: issuing stock to employees doesn’t require writing a check. No cash leaves the company’s bank account during the reporting period, so stripping out the expense arguably gives a cleaner view of how much cash the business generates from operations.
The adjustment is popular among technology and high-growth companies where equity grants make up a large share of total pay. Comparing a startup that pays engineers mostly in stock against an established firm paying cash salaries gets easier when you remove SBC from both sides.
Credit agreements often permit this add-back too. Lenders defining “Consolidated EBITDA” in loan covenants commonly include language allowing borrowers to add back non-cash stock compensation. A company’s ability to meet its debt covenants can therefore depend on the adjusted number rather than the standard one.
The Case for Treating SBC as a Real Cost
Not everyone accepts the “non-cash, so ignore it” logic. Warren Buffett has argued for decades that stock-based compensation is a genuine economic cost that should not be excluded from earnings. His point: if a company had to pay those same employees in cash, no one would exclude that salary from an earnings calculation. The fact that the cost shows up as dilution rather than a wire transfer doesn’t make it free.
Dilution is the substance of the objection. When a company issues new shares to employees, existing shareholders own a smaller slice of the business. Over time, heavy SBC can erode the value of each outstanding share. A company reporting strong Adjusted EBITDA growth while quietly issuing billions in stock grants is flattering its numbers at shareholders’ expense.
The SEC has flagged this tension. Agency guidance warns that excluding “normal, recurring, cash operating expenses necessary to operate a registrant’s business” from a non-GAAP measure can make that measure misleading under Regulation G.1U.S. Securities and Exchange Commission. Non-GAAP Financial Measures SBC itself is non-cash, but the staff views any expense that recurs as recurring rather than one-time, and evaluates each adjustment against the specific facts of the company.
What the Gap Between the Two Figures Tells You
The enterprise value to EBITDA ratio is one of the most common tools for comparing companies, and which version of EBITDA sits in the denominator matters. Using Adjusted EBITDA produces a lower multiple, making the company look cheaper. Using standard EBITDA produces a higher multiple, making it look more expensive. Neither is wrong on its own, but mixing them across two companies gives nonsense results.
A useful habit is to calculate both and look at the spread. A company where the two are nearly identical has minimal SBC relative to earnings. A company where Adjusted EBITDA runs 40% above standard EBITDA is leaning heavily on equity compensation, and that gap is a prompt to check the dilution trajectory. If the share count is growing 5% or more per year from stock grants, per-share economics are deteriorating even as total Adjusted EBITDA rises.
The Free Cash Flow Inconsistency
SBC is treated differently in free cash flow calculations than in EBITDA, and the inconsistency trips people up. On the cash flow statement, SBC appears as a non-cash add-back in the operating activities section, so it lifts cash from operations the same way depreciation does. Because free cash flow to equity is typically cash from operations minus capital expenditures, SBC ends up excluded from the cost base there too.
Some valuation experts, including NYU professor Aswath Damodaran, argue that SBC should be subtracted from cash from operations when computing free cash flow because it is a real economic cost to shareholders. The standard practice of adding it back in both EBITDA and free cash flow effectively double-counts the benefit, making companies look more cash-generative than they are for existing owners. In a discounted cash flow model, how you handle SBC in projections can swing implied valuation by 10% to 20% for SBC-heavy companies.
How to Calculate Adjusted EBITDA Yourself
The math is straightforward once you have the inputs. Start with net income. Add back interest expense, income tax expense, depreciation, and amortization to get standard EBITDA. Then add the total stock-based compensation figure from the cash flow statement. That is Adjusted EBITDA excluding equity grants.
An example: a company reports net income of $80 million, interest expense of $10 million, taxes of $25 million, depreciation and amortization of $30 million, and stock-based compensation of $50 million. Standard EBITDA is $145 million. Adjusted EBITDA is $195 million. That $50 million gap is the SBC cost, and whether the company’s “real” profitability is $145 million or $195 million depends on which side of the debate you land on. Most experienced investors calculate both and watch how fast the gap widens year over year.
Where to Find the SBC Number
You need the actual SBC dollar amount to run the calculation, and the fastest place to find it is the cash flow statement in a company’s 10-K or 10-Q filing with the SEC. Look under the section reconciling net income to cash provided by operating activities. Stock-based compensation gets its own line item there, showing exactly how much non-cash expense was added back to arrive at operating cash flow.
For more detail, check the notes to the financial statements. Companies break down equity compensation by award type, with separate figures for stock options, restricted stock units, performance shares, and employee stock purchase plan costs. The notes also disclose the valuation assumptions behind those numbers, such as expected volatility and the risk-free rate used in option pricing models. Those details help you judge whether SBC is likely to grow, shrink, or stay flat.
SEC Rules for Reporting Adjusted EBITDA
Companies cannot publish Adjusted EBITDA in a vacuum. Under Regulation G, whenever a company releases a non-GAAP metric, it must also present the most directly comparable GAAP measure and provide a quantitative reconciliation showing how it got from one to the other.2eCFR. Part 244 Regulation G For Adjusted EBITDA, that means starting with GAAP net income and walking through every adjustment, including the SBC add-back, line by line.
SEC rules also prohibit calling a modified earnings metric simply “EBITDA” when it includes adjustments beyond the standard four add-backs. A measure that adds back stock-based compensation has to be labeled something like “Adjusted EBITDA” so investors know it is not the standard definition.1U.S. Securities and Exchange Commission. Non-GAAP Financial Measures Companies filing with the SEC must also explain why management believes the adjusted measure provides useful information to investors and disclose the internal purposes for which they use it.3eCFR. 17 CFR 229.10 – (Item 10) General