Earnings Quality, Capital Structure, and the Structural Bridges Between Buyers and Sellers
Written by Lukas Wenzel & Markus Schupp of Westfalenfinanz
For many owners, selling a business is a once-in-a-lifetime event – the financial culmination of decades of entrepreneurial work. It represents far more than a liquidity event. It is the monetization of a lifetime of entrepreneurial work.
Yet beneath the emotion lies a disciplined financial process. A sale is not defined by intent, but by preparation, structure, and credibility of information.
Too often, companies enter a sale process without the financial transparency required to command premium valuations. Financial statements may suffice for internal management purposes, yet they rarely meet institutional due diligence standards. Forecasts exist, but are often not built on robust, data-driven assumptions. Most critically, the integration between income statement, balance sheet, and cash flow is not fully developed.
In M&A, transparency is not an administrative exercise. It is a value driver.
Buyers pay for what they understand—and discount what they do not.
In the mid-market, valuation is typically determined by applying a multiple to normalized, sustainable operating earnings—most commonly EBITDA or EBIT—to derive Enterprise Value. However, Enterprise Value is only the starting point. The actual proceeds to the seller depend on three critical factors:
- Normalized, sustainable earnings (Quality of Earnings)
- The conversion of Enterprise Value into Equity Value (Equity Bridge)
- Deal structuring mechanisms to bridge valuation gaps between buyers and sellers.
1. Quality of Earnings – The Foundation of Value
Reported earnings rarely reflect true economic performance. Financial statements are prepared for compliance purposes, not for valuation. As a result, reported EBITDA or EBIT often contains non-recurring, discretionary, or non-operating items.
The central question for any buyer is straightforward: How repeatable are these earnings?
Typical normalization adjustments include:
- Non-recurring revenues
- Owner or founder compensation above or below market levels
- One-time legal or advisory expenses
- Personal or discretionary expenses
- Extraordinary costs such as expansion initiatives or ERP implementations
The outcome is normalized EBITDA – a measure of sustainable earnings capacity. A robust, well-documented Quality of Earnings analysis reduces uncertainty, strengthens buyer confidence, and directly supports higher valuation multiples.
2. From Enterprise Value to Equity Value – Converting Valuation into Proceeds
Enterprise Value reflects the value of the business independent of its capital structure. The bridge to Equity Value determines the actual purchase price.
The Equity Bridge framework typically includes:
- Enterprise Value
- Plus: Cash and cash equivalents
- Plus: Non-operating financial assets
- Plus: Other cash-like items
- Less: Bank debt
- Less: Shareholder loans
- Less: Pension and tax liabilities
- Less: Other debt-like items
- Plus / Minus: Working Capital adjustments.
- Plus / Minus: CAPEX adjustments
- = Equity Value (Purchase Price)
Debt reduces proceeds on a dollar-for-dollar basis, while excess cash increases proceed accordingly. The Equity Bridge therefore determines the seller’s actual closing proceeds.
3. Bridging Valuation Gaps – Structure as a Solution
Buyers and sellers evaluate the same business through different lenses. Structural solutions are designed to align incentives and bridge valuation gaps.
Earn-Out – Aligning Price with Performance
An earn-out links a portion of the purchase price to future performance, aligning expectations and mitigating valuation risk for both parties.
Rollover Equity – Extending Ownership into the Future
Rollover equity enables sellers to reinvest part of their proceeds and participate alongside the buyer in future upside.
Vendor Loan – Facilitating Transaction Execution
A vendor loan defers a portion of the purchase price, increasing financing flexibility and facilitating transaction execution.
Conclusion
Enterprise Value is not a standalone number. It is the outcome of earnings quality, capital structure, and deal structure. A rigorous Quality of Earnings analysis, a disciplined Equity Bridge, and thoughtfully structured transaction mechanisms form the foundation of successful deals.
Transaction value is realized when financial performance is transparent, risks are appropriately allocated, and incentives are structurally aligned.
This article was originally published at https://ma-review.de/artikel/unternehmenswert-verstehen-von-der-ergebnisqualitaet-bis-zum-finalen-kaufpreis
