Why “Owner-Adjusted EBITDA” Breaks Down Faster Than You Think

Category: Valuation
Read Time: ~5 minutes

Owner-adjusted EBITDA is one of the most common — and most abused — concepts in lower-middle-market transactions.

In principle, it is meant to normalize earnings by removing expenses that will not continue under new ownership. In practice, it often becomes a convenient way to make a business look more profitable than it truly is.

The problem is not that adjustments exist.
It’s how quickly they collapse under scrutiny.

Adjustments Are Assumptions About Behavior

Every EBITDA adjustment is a statement about what will change after closing.

When a seller claims certain expenses are “non-recurring” or “owner-specific,” they are implicitly asserting that the buyer will not need to replace those functions in some form. That assertion deserves as much diligence as revenue itself.

Too often, adjustments are accepted because they sound reasonable — not because they are durable.

Where Adjustments Most Commonly Fail

Owner-adjusted EBITDA tends to break down in a few predictable areas.

Compensation is the most obvious. Removing an owner’s salary assumes that leadership, oversight, and decision-making can be absorbed without replacement. In reality, those responsibilities rarely disappear. They are either transferred to another employee or to the buyer — both of which have real cost.

Professional fees are another common adjustment. Sellers often argue that legal, accounting, or consulting expenses were tied to unusual events. Sometimes that is true. Often, those expenses reflect a lack of internal capability that will persist after closing.

Even “one-time” operational costs deserve skepticism. Many are only one-time because the business has not yet tried to scale, integrate systems, or professionalize operations.

The Compounding Effect Buyers Miss

Each individual adjustment may seem small and defensible.

The problem emerges when adjustments are stacked.

A business with multiple aggressive addbacks often requires several things to go right simultaneously for EBITDA to hold: smoother operations, fewer external advisors, no additional management hires, and uninterrupted performance during transition.

That is a fragile underwriting — even if the math works on paper.

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The Stress Test That Never Happens

Structural weaknesses often reveal themselves only under stress.

Stress can take many forms: a key employee leaves, a large customer renegotiates, costs rise unexpectedly, or the owner steps back. These are not extreme scenarios. They are normal events over a multi-year hold.

When a business has not been built to absorb change, even small disruptions can have outsized impact — regardless of historical cash flow.

What Diligence Should Do Instead

Good diligence uses cash flow as a starting point, not a conclusion.

It asks how dependent that cash flow is on specific people, behaviors, or conditions. It looks for evidence that the business can function without constant intervention. It evaluates whether the organization can absorb growth, change, or loss without breaking.

The goal is not to discredit cash flow — it is to understand what supports it.

Practical Takeaway

Strong cash flow should increase curiosity, not reduce it.

When cash flow looks good, that is precisely when buyers should ask harder questions about structure, repeatability, and resilience. The more attractive the numbers, the more important it is to understand what happens when conditions shift.

Closing Thought

Cash flow tells you what the business has been able to do.

Structure tells you what the business will be able to survive.

Conflating the two is one of the most common — and costly — mistakes in lower-middle-market investing.