From Reported EBITDA to Underwritten EBITDA: What Really Drives Middle-Market Valuation

In an earlier article, Tanishq Agrawal discussed how the same financial statements can lead to different conclusions depending on who is reading them. Once a business enters a sale process, that question becomes more specific: what level of earnings will a buyer actually be prepared to underwrite?

That is where the distinction between reported, normalized and underwritten EBITDA becomes important.

Reported EBITDA reflects what the business generated historically. Normalized EBITDA adjusts those results for items that are not expected to continue. Underwritten EBITDA is the portion of that earnings case a buyer is ultimately comfortable relying on when determining value.

The differences between those numbers can be meaningful.

Common adjustments may include normalized owner compensation, one-time professional fees, personal expenses that will not continue under new ownership, or other clearly non-recurring costs. But an adjustment does not create value simply because it appears in an EBITDA bridge.

An adjustment should not simply make sense to management. It should be capable of being explained, documented and defended when a buyer tests it.

A cost reduction already implemented and visible in recent monthly results is different from one management expects to achieve several months from now. Likewise, a one-time expense supported by clear documentation is easier to substantiate than an adjustment based primarily on judgment.

We encounter this regularly in middle-market sale processes. Historical results establish the starting point, while normalization adjustments and recent operating changes may support a different view of earnings. The work is not to identify the highest possible EBITDA figure. It is to build a clear bridge from what was reported to what can reasonably be supported.

Why does this matter so much? Because even a relatively small difference in EBITDA can have a much larger impact on valuation.

For example, if a seller presents $5.0 million of adjusted EBITDA but a buyer ultimately underwrites $4.5 million, the disagreement is not limited to $500,000 of earnings. At an illustrative 6.0x multiple, that difference can translate into a $3.0 million valuation discussion.

There is another important distinction. Agreeing on EBITDA does not automatically determine value.

As Tom often reminds us, valuation is not simply a matter of applying an industry multiple to earnings. Two businesses with the same EBITDA can command very different values depending on the durability of those earnings, growth prospects, customer concentration, management depth and overall risk profile.

The EBITDA establishes a foundation. The multiple reflects how the buyer views the quality and risk of the business built on top of it.

At Ravinia, we consistently emphasize doing this work before a business goes to market. The goal is to understand which adjustments can be supported, where a buyer may push back, and whether the underlying documentation is ready before those questions begin affecting an LOI or confirmatory diligence.

For some businesses, that preparation may also include a sell-side quality of earnings review. A QoE can help test the earnings bridge, identify potential issues early and provide additional support for key adjustments before a buyer conducts its own diligence.

The objective is not to present the highest EBITDA number. It is to enter the market knowing which earnings can be supported, which assumptions may be challenged and what a buyer is likely to underwrite.

Because once a multiple is applied, even a relatively small disagreement over EBITDA can become a much larger disagreement over value.