The quality of earnings is what can change the price
“Joshua, I’ve been told that JBL Sistemas was paid 10x EBITDA. All the offers we’re getting are coming in between 6x and 7x.”
“I’ve reviewed the accounts at the Companies Registry. They basically do the same thing we do, they’re a similar size, and they have a very similar EBITDA margin, around 15%. I don’t understand it.”
If the sector is the same, the size is similar, and profitability is similar, where’s the difference?
It may be that those 10x EBITDA are simply market gossip. Like the apartment downstairs, which the doorman says sold for €6,000 per square meter, when in reality prices in the area rarely exceed €3,000.
It could also be that 10x EBITDA was not actually paid for the firm. There is a lot of storytelling in the market around prices. The round number gets repeated, but the full structure is rarely explained: what portion of the price was paid upfront and what portion was left as a variable component (earn-out), contingent on achieving certain results over the next two or three years.
There is, of course, a third possibility: that the price was indeed 10x on a comparable basis, but that the quality of earnings of JBL Sistemas is very different from that of the company owned by the entrepreneur who raised the question.
Let me give a few examples to make it clearer.
There are two companies in the same sector generating €20 million in revenue and €3 million in EBITDA.
Which one would you pay more for?
Or which one would you buy, if you could choose?
Again, two companies, same sector, same revenue, same EBITDA.
Which one would you choose?
You don’t need to be a finance expert to sense the answer.
“Quality of Earnings” is the analysis that goes beyond the simple figures and seeks to truly understand what lies behind EBITDA.
▪️ What portion is recurring
▪️ What portion is sustainable
▪️ What portion converts into cash
▪️ What risks lie behind the number
A buyer does not pay for historical EBITDA. They look at the past to try to estimate the probability that revenue, margins, and cash generation will be maintained in the future. The analysis goes far beyond the simple revenue and EBITDA figure from the last year.
The buyer looks at contracts, average duration, historical renewal rates, and real visibility into the following year.
It is not the same to have revenues signed for several years as it is to depend on occasional orders confirmed month by month. Visibility reduces uncertainty and makes earnings more predictable.
Concentration and dependency are analyzed.
If one customer represents a very significant portion of revenue, losing that customer completely changes EBITDA. A more diversified base makes results more stable and reduces perceived risk.
EBITDA is not cash. Cash is what sits in the bank accounts at year-end.
The buyer analyzes how that EBITDA translates into real cash flow: working capital requirements, CAPEX investments, and differences between accounting profit and actual cash generated.
€2 million of EBITDA where half a million comes from capitalized costs or internally capitalized work is not the same as €2 million where virtually all of it is “cash EBITDA.”
The level of adjustments required to reach normalized EBITDA is analyzed.
The more extraordinary items, non-recurring entries, and explanations required, the greater the doubt about the result.
An EBITDA figure requiring few adjustments conveys more confidence than one that needs dozens of reconciliations.
The buyer tries to understand where growth comes from.
Whether it has been achieved while maintaining margins or by compressing them.
Whether the company has grown consistently for several years or whether the last year was particularly strong due to something one-off that may not be repeated.
Whether the growth is truly profitable or has been forced by raising prices, tightening customer terms, or accepting lower-margin projects—potentially creating more churn or pressure in the future.
In recurring businesses, churn is obviously a key point.
Historical cancellation rates, their evolution, and the ability to retain and expand existing customers are analyzed. A business that constantly loses customers and needs to replace them to maintain revenue has a different risk profile from one with high retention and stability in its installed base.
Many of these elements are typically analyzed before presenting an LOI (Letter of Intent). It is very rare for a buyer to put a price on the table without having reviewed at least customer concentration, churn evolution, and EBITDA-to-cash conversion.
Unfortunately, it is not uncommon for an acquirer to renegotiate the price after due diligence due to issues related to quality of earnings. Even without direct adjustments to EBITDA, a buyer may conclude that the security of future cash flows (which is what truly matters) is substantially lower than initially perceived and request a price reduction.
In those cases, in my experience, the buyer does not usually ask for a reduction in the nominal price. After all, if there is no adjustment to EBITDA, it is difficult to justify a change in price. However, what they often do is maintain the headline price while introducing a contingent variable component—for example, tied to the renewal of certain contracts, the maintenance of margins, or the achievement of specific targets. In any case, this is rarely pleasant for the seller.
By Joshua Novick, partner at Bondo Advisors
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