Due Diligence in the Age of Adjusted EBITDA

Every transaction now arrives with an adjusted earnings figure and a schedule explaining it. Some adjustments are entirely legitimate. Others are aspirations presented as accounting.

Financial due diligence tests whether the adjustments are calculated correctly. Operational due diligence asks a different question: can this business actually deliver the run rate the adjusted figure implies?

Interrogate the normalisations

Certain adjustments deserve particular attention. Owner remuneration normalised to market rate, where the owner performed three roles. Costs described as one-off that appear in three consecutive years. Synergies credited before the transaction has closed.

The test is whether the cost genuinely disappears under new ownership or simply moves. Frequently it moves.

Deferred spending flatters the current year

A business being prepared for sale often defers maintenance, delays hiring, cuts marketing and stretches supplier payments. Earnings improve and the underlying capability degrades.

These are visible if you look for them: capital expenditure below depreciation, rising average asset age, headcount flat while revenue grows, creditor days extending. The buyer inherits the deferred cost and it lands in the first year.

Customer concentration behind the revenue line

Revenue quality matters more than revenue growth. Check the contract length, the renewal history, and whether the relationships sit with the business or with the departing owner.

A business where the top customers were personally held by a founder who is leaving has a different risk profile from one with institutional relationships, and the earnings multiple should reflect it.

Ask whether the operating model scales

Growth assumptions in a model are frequently unconstrained by operational reality. If the plan requires doubling volume, ask what physically has to change: capacity, people, systems, supply.

Where the answer is that the current model simply runs harder, be sceptical. Most operations have a constraint that appears somewhere below double.

Spend time on site

The most useful diligence hours are usually spent in the operation rather than in the data room. Walk the facility, watch the process, talk to supervisors rather than executives.

Data rooms contain what the vendor chose to include. A morning spent watching how work actually flows tells you whether the adjusted figure describes a business that exists or one that would have to be built.

It is also where you meet the people who will still be there after completion. Their view of what works and what is held together informally is rarely in any document, and it is usually the most accurate forecast available.