Is the profit you're presenting the profit the buyer will accept?

In almost every business sale negotiation, there's a silent mismatch right from the start, because the seller looks at the profit recorded in their financial statements while the buyer looks at the profit they consider sustainable and repeatable. This difference is far from being a technical detail, as it defines the price and, in many cases, the very viability of the transaction.

The Concept of Quality of Earnings (Quality of Results)

The most sophisticated buyer evaluates the company based on the quality of its results, which is commonly called... quality of earnings, This is almost always part of an adjusted EBITDA, so accounting profit serves as a starting point and not as a destination. Adjustments are made to this figure in two directions: deductions for non-recurring revenues and results, and additions for non-recurring, non-operating, or stand-alone adjustable expenses.

The Most Frequent Adjustments to EBITDA

The most frequent adjustments are quite predictable for anyone who has gone through such a process, and range from partners' personal expenses charged to the company to the pro-labore set above or below market value, including transactions with related parties under non-market conditions, extraordinary revenues, contingencies that were not provisioned, and isolated events that distort the period's result. The net effect of all this is that the profit capable of sustaining the multiple may be quite different from the profit that appears on the balance sheet.

Impacts on Due Diligence and Contract Structuring

This examination takes place during the financial due diligence conducted by the buyer; its conclusions are reflected in the structure of the deal, influencing the price and the choice between financing mechanisms. locked-box and closing accounts, the potential requirement of earn-out, the retention of part of the price in escrow and the scope of representations, warranties, and indemnities. A significant adjustment that only appears late ends up eroding not only the price but also the trust that underpins the negotiation.

Prior Preparation and the Strategic Role of the Legal Department

The seller, however, controls a good part of this narrative, provided they prepare in advance, organizing the numbers before taking the company to market, separating what is recurring from what is episodic, documenting the rationale for each adjustment, and eliminating over time practices that generate noise, such as mixing personal expenses with company expenses and poorly formalized contracts with related parties, which are usually precisely the type of surprise capable of stalling the negotiation.

Alongside the financial advisor, the legal department's role is to anticipate these points and translate them into the pricing structure and risk allocation of the contract, because preparing the quality of profit before the competitive process is usually worth much more than trying to defend it afterward. It is in this preparation and in the negotiation of instruments that protect the value effectively built that M&M operates.

Article prepared by: Antonio Mazzucco, Marina Moreno and Paula Suraci.