Why You Can’t Trust EBITDA Multiples in M&A

An asking price of €8 million against reported EBITDA of €1.4 million produces an apparently attractive headline multiple of approximately 5.7×. The factory is operating, the equipment is installed, employees are in place, and the buyer would acquire an existing customer base. Those facts make the opportunity easy to understand, but they do not make it ready for investment approval.

An investment committee must approve the cash flow and risk that will remain after ownership changes. That requires a reconstruction of the earnings, the customer base, the assets, the working-capital position, and the full amount of cash needed to complete and stabilize the acquisition.

Central question: Are the earnings repeatable, are the important customer relationships transferable, and how much cash must the buyer actually commit?

The headline EBITDA multiple is only a starting point

A purchase-price-to-EBITDA multiple is useful as an initial screening ratio. It becomes misleading when reported EBITDA includes income that will not recur, excludes costs that a new owner must bear, or ignores the capital required immediately after closing.

In this illustrative case, the seller reports €1.4 million of EBITDA. Diligence identifies €250,000 of non-recurring profit that cannot support a recurring valuation. The review of owner compensation and replacement management produces a net positive adjustment of €30,000. The normalized calculation is therefore:

EBITDA bridge	Amount	Investment implication
Reported EBITDA	€1.40 million	The seller’s headline earnings figure
Less: non-recurring profit	(€0.25 million)	One-time income removed from recurring earnings
Add: net management adjustment	€0.03 million	Owner compensation and replacement-cost adjustment
Normalized EBITDA	€1.18 million	The earnings base used for underwriting

The €8 million price has not changed, but the defensible earnings base has. The multiple increases from approximately 5.7× reported EBITDA to about 6.8× normalized EBITDA. That does not establish whether the company is cheap or expensive. It shows why a multiple has meaning only when the earnings beneath it are supportable.

Customer concentration can overwhelm the earnings case

The company generates €12 million of annual revenue, but 45% comes from one customer. That represents €5.4 million of revenue tied to a single commercial relationship. Concentration is not automatically unacceptable: a large relationship may be durable, profitable, transferable, and contractually protected. The buyer must prove those characteristics rather than assume them.

The diligence review should establish:

• How long the relationship has existed and how revenue and margin have developed by month.
• Whether the contract can be terminated for convenience.
• Whether a change of control requires the customer’s consent.
• Whether backlog, order history, receivables, and customer behavior support continuity.
• Whether the account produces an acceptable contribution margin after service and delivery costs.

A downside sensitivity illustrates the exposure. If the €5.4 million of concentrated revenue contributes a 25% margin, a complete loss removes €1.35 million of contribution before cost reductions. That amount exceeds normalized EBITDA of €1.18 million. The exact result depends on actual margins and removable costs, but the strategic conclusion is clear: without evidence about the customer, the buyer is underwriting a relationship rather than a stable earnings stream.

The purchase price is not the total investment

Even if normalized earnings survive diligence, the quoted €8 million price is not the complete cash requirement. An equipment review identifies €800,000 of deferred capital expenditure, while the working-capital analysis identifies another €600,000 that must be funded at closing.

Sources-and-uses item	Amount
Purchase price	€8.00 million
Deferred capital expenditure	€0.80 million
Working-capital shortfall	€0.60 million
Pre-fee cash requirement	€9.40 million

Dividing €9.4 million by normalized EBITDA of €1.18 million produces an all-in multiple of approximately 8.0× before transaction fees, financing costs, taxes, or unresolved liabilities. Cash that appeared available for growth may instead be needed to repair equipment or refill the operating cycle.

This is why the investment committee needs both a purchase-price bridge and a complete sources-and-uses schedule. The quoted price describes the payment to the seller; it does not necessarily describe the cost of acquiring a stable, adequately funded business.

Evidence required before committing capital

The attractive version of the transaction can still be valid, but it must be rebuilt from evidence. A disciplined review would normally cover the following areas.

Quality of earnings

• Reconcile at least three years of financial statements to monthly management accounts.
• Separate recurring operations from owner choices, one-off income, and unsupported add-backs.
• Review payroll and establish a credible post-closing management plan.

Customers and contracts

• Analyze revenue and margin by customer and by month.
• Review contract duration, termination rights, change-of-control provisions, backlog, and receivables.
• Conduct customer discussions only through the agreed process and confidentiality rules.

Cash, assets, and liabilities

• Rebuild normalized working capital and test the cash needed through the operating cycle.
• Separate maintenance capital expenditure from growth investment and inspect material equipment.
• Verify environmental, permit, title, tax, litigation, warranty, and financing matters with qualified advisers.

Use transaction structure to allocate uncertainty

When the commercial case is credible but evidence remains incomplete, the answer does not have to be an immediate yes or no. The buyer can renegotiate the price, link an earn-out to customer retention, request a seller note, hold proceeds in escrow, or make closing conditional on customer consent, contract renewal, or another defined milestone.

These mechanisms do not eliminate risk. They allocate risk between the parties. A practical principle is that the party claiming uncertain future value should not automatically receive all of that value in cash on closing day.

Buy, renegotiate, or pass?

Buy

Proceed when normalized earnings are supported, the major customer relationship is transferable, the all-in cash requirement is funded, and the downside case still leaves adequate liquidity.

Renegotiate

Renegotiate when the price assumes earnings, customer continuity, or asset condition that has not been proven. Adjust the price, payment timing, closing conditions, or risk allocation until the structure matches the available evidence.

Pass

Decline the transaction when central assumptions cannot be verified, the principal customer can leave without protection, liabilities remain unbounded, or the financing works only under the seller’s optimistic case.

The reconstructed investment case

The original presentation describes an €8 million acquisition at approximately 5.7× reported EBITDA. The reconstructed case requires €9.4 million before fees, equates to approximately 8.0× normalized EBITDA, and depends on a customer representing 45% of revenue.

That analysis does not prove the factory is a poor acquisition. It proves that the headline multiple is not the investment decision. The decision must rest on normalized cash generation, customer transferability, the complete funding requirement, and a transaction structure that reflects the evidence.

Najafi Capital helps buyers organize the investment case, evidence requirements, and transaction structure before approaching the market or committing capital. Every conclusion must be verified for the specific company, transaction, and jurisdiction.