The EBITDA Trap in Middle-Market M&A

In the middle market, where thousands of private businesses change hands every year, one number dominates the conversation: EBITDA. Short for earnings before interest, taxes, depreciation, and amortization, it has become the shorthand for value. A company might be said to trade at “six times EBITDA” or “eight times EBITDA,” as if that alone explains its worth.

But EBITDA is not a fact of nature. It is an accounting construct, one that is often open to interpretation. The number presented in a financial statement is usually the starting point, not the finish line. Sellers and buyers both know this, which is why EBITDA is almost always adjusted. When corrected for one-time costs, discretionary owner expenses, or investments in growth, it becomes “adjusted EBITDA.” And adjusted EBITDA, far more than the raw number, is what drives valuation.

That’s where the stakes rise. At a seven-times multiple, every additional dollar of EBITDA translates into seven dollars of enterprise value. A $100,000 adjustment in the earnings line can shift a deal price by $700,000. In larger transactions, the gap can run into tens of millions. The math is simple, but the implications are profound. For sellers, it is the single most powerful lever they control in a negotiation.

This leverage also makes adjusted EBITDA the most contentious part of the M&A process. Sellers argue for every add-back they can reasonably justify. Buyers probe each adjustment, benchmarking margins against industry peers and questioning whether costs are truly one-time in nature. If the gulf between the two sides grows too wide, deals stall, valuations fall, and in some cases disputes spill into litigation.

The risk is particularly acute for private owners in the lower middle market, many of whom have managed their businesses with a focus on minimizing taxable income rather than maximizing reported profitability. Family members might draw salaries above market levels. Personal vehicles or travel could appear on the company books. In some cases, real estate or equipment expenses blur the line between personal and corporate. All of these items can become adjustments in a sale process. If they can be substantiated. If they cannot, the credibility of the entire financial story is at risk.

Buyers have seen it all before, and they are quick to push back. They know that not every “one-time” expense is truly one-time, and not every owner expense can be fully carved out. A recurring legal dispute, for example, should not be treated as an isolated event. A marketing program that runs every year is not a temporary investment. What looks like an add-back to a seller often looks like ongoing cost to a buyer.

The best sellers prepare for this reality. They do not wait for a buyer’s diligence team to uncover weaknesses. Instead, they commission a quality of earnings review before going to market. An independent assessment of adjusted EBITDA carries weight in negotiations, demonstrating that the seller’s financial story has been vetted by professionals. It builds credibility, reduces the risk of re-trading, and often justifies a higher multiple.

Documentation is equally important. Every adjustment should be backed by invoices, contracts, or other clear records. Sellers who can point to paper trails earn trust. Those who rely on vague explanations or memory risk losing it. Consistency matters as well. If adjustments are made one way in 2023 and another way in 2024, buyers will question the validity of both.

There are useful benchmarks that sellers should keep in mind. Owner compensation is often the largest adjustment in a middle-market transaction, but it should be tied to a market-based salary for the role. Adjusted EBITDA margins should fall within a range consistent with industry peers; if margins appear far above market, buyers will assume aggressive accounting or unsustainable performance. Recurring earnings carry the most weight in valuation, while temporary spikes are discounted heavily.

Timing also plays a role. Selling after a strong operating year, when earnings are stable and visible, can add turns of multiple compared with selling in the midst of heavy investment. Growth initiatives may warrant adjustments, but buyers want a clear line of sight into the returns. Strong, defensible EBITDA also enables acquirers to raise more debt, which in turn supports higher valuations.

The broader lesson is that EBITDA is both powerful and fragile. It is powerful because it sets the terms of valuation. It is fragile because it depends on trust. A seller who inflates adjusted EBITDA risks not only a lower price but also reputational damage in the market. A buyer who dismisses legitimate adjustments risks walking away from a deal that could have been accretive.

For private owners, this means reframing how they think about financial performance long before a sale process begins. The habits of minimizing taxable income, while sensible year to year, can reduce enterprise value when the time comes to exit. Building a clear and defensible EBITDA story requires discipline, foresight, and professional preparation.

For buyers, the takeaway is different. Do not be seduced by headline multiples. Dig into the adjustments. Ask whether earnings are sustainable, whether the growth story holds, and whether the normalized performance can truly repeat. The value of a business is not in the multiple itself but in the credibility of the EBITDA on which it rests.

In theory, EBITDA brings discipline by standardizing the measure of profitability. In practice, it often introduces a new layer of negotiation. The number that drives valuation is less about accounting rules than about evidence, documentation, and credibility.

For sellers, the message is clear. EBITDA is the currency of M&A, but only if the numbers add up.