Every investor knows that EBITDA is not just an acronym - it is a kind of litmus test for a business's profitability. The final price of a deal often hinges on this very metric. Yet every business has its own skeletons in the closet - risks that can wreck a deal if you fail to spot them in time.
A classic comprehensive review can take weeks, but in a fiercely competitive market an investor often has just 72 hours to make a make-or-break decision. How do you turn, in that short window, from a naive buyer into a skeptic able to see the real EBITDA picture, cleansed of any window dressing? Here is a step-by-step strategy.
Step 1. Why normalization matters
The seller always strives to look as attractive as possible. That is precisely why they lead with adjusted EBITDA.
Where is the catch? In a creative approach to adjustments. In the chase for a higher multiple, management may strip out of EBITDA any expense it labels "one-off" or "extraordinary." But what is a unique situation for the seller may be business as usual for the new owner.
Request a breakdown of every adjustment made to arrive at EBITDA. Each item must be supported by source documents. If it is not, you are looking at an attempt to dress up reality.
Step 2. The three-day blitz-review plan
A 2-3 day express financial DD is feasible. To make it in time, follow the playbook.
Consolidated statutory and IFRS statements for 3 years. The gap between net profit and EBITDA, and the quality of receivables.
Related-party transactions: hidden bonuses, above-market rent, one-off "wins" in income and expenses.
Counterparties in corporate and tax-authority registries, litigation, and the Net Debt / EBITDA leverage.
Day 1. The accounting rear (reviewing the financials)
Analyzing the consolidated financials (statutory and IFRS) for 3 years is the baseline. Comparing IFRS and statutory data often exposes manipulation - for example, agency arrangements or the write-off of deferred expenses.
What to check:
- The gap between net profit and EBITDA. A wide gap with low depreciation may point to hidden non-operating expenses.
- The quality of receivables. EBITDA growth alongside stale receivables is a sign of "paper" income.
Day 2. Transaction surgery (the business and its deals)
We examine internal operations. The most dangerous findings hide in related-party transactions.
- Hidden bonuses and rent. If the CEO is paid below market but owns the premises and leases them to the company at above-market rates, the real value of the business is understated while EBITDA is not.
- One-off wins. Identifying non-operating income (for example, the sale of an asset) or expenses (for example, legal penalties) and then excluding them from the base used to calculate sustainable cash flow.
Day 3. The legal trigger (legal audit and debt)
Legal cleanliness is the guarantee that EBITDA will not be eaten away by lawsuits the day after the purchase.
- Checking counterparties in corporate and tax-authority registries for losses or "shell" status.
- Analyzing litigation and reputational risks that could hit the bottom line.
- Assessing leverage: a Net Debt / EBITDA > 3 ratio is a heightened-risk zone.
When Net Debt / EBITDA exceeds 3, the business is working for its lenders: a significant share of cash flow goes to servicing loans rather than to growth and dividends for the new owner.
Step 3. Red flags: when EBITDA turns into a trap
An experienced investor looks not for numbers but for the logic of the business.
| Red flag | What to check | What it signals |
|---|---|---|
| Customer concentration | 20-30% of the base in revenue and EBITDA | The business is fragile: losing a couple of clients would collapse profit |
| Cash conversion | CFO consistently below EBITDA | The company is consuming capital on working capital rather than generating it |
| Quality of receivables | EBITDA growth with stale receivables | "Paper" income with no real cash |
| Related-party deals | Above-market rent and services from related parties | Hidden EBITDA adjustments, understated real base |
| Leverage | Net Debt / EBITDA > 3 | Heightened-risk zone for debt service |
- Customer concentration. If EBITDA rests on 20-30% of the client base, the business is fragile.
- Cash conversion. Compare cash flow from operations (CFO) with EBITDA. If CFO is consistently below EBITDA, the company is consuming its capital to maintain working capital rather than generating it.
An experienced investor looks not for numbers but for the logic of the business: sustainable EBITDA is the kind that is backed by real cash flow.
Need an objective assessment before a deal?
Only a comprehensive review protects you from losing money and reputation. G-Invest runs express and extended due diligence, normalizes EBITDA, and uncovers the skeletons in the closet before you sign.
Frequently asked questions
How much does due diligence cost?
The cost of a review depends on scope. An express DD can start from around $1,700, while an extended review starts from around $5,500.
What is Quality of Earnings (QoE) and why does it matter?
It is an analysis of earnings quality. It checks how sustainable your EBITDA is - whether it has been inflated by one-off income or by under-reserving. QoE is the only way to see the real operating cash flow.
Can EBITDA be negative?
Yes. Negative EBITDA means the company's core operations are loss-making. In an M&A deal this often calls for a substantial discount of up to 50-70%.