Understanding Financial Metrics in an M&A Transaction

In middle-market mergers and acquisitions (M&A) transactions, financial metrics play a critical role in valuation, negotiation, and deal structuring. Buyers and sellers rely on these metrics to determine fair market value, financial performance, and post-closing adjustments.

For business owners in Arizona, Scottsdale, and Phoenix considering a sale, understanding key M&A financial concepts can help maximize deal value and avoid common pitfalls. This guide explains essential financial metrics, including enterprise value, equity value, EBITDA, and the working capital peg, with a focus on cash-free, debt-free transactions, which are standard in middle-market M&A.

1. Enterprise Value vs. Equity Value in a Cash-Free, Debt-Free Transaction

In middle-market M&A, transactions are typically structured on a cash-free, debt-free basis. This means the seller retains all cash and cash equivalents, while the buyer assumes no existing debt obligations at closing.

Enterprise Value (EV)

Enterprise value reflects the total value of the business operations, independent of how the company is financed. It represents the amount a buyer is willing to pay to acquire the business before adjusting for cash, debt, and working capital considerations.

Formula:

Enterprise Value=Equity Value+Debt−Cash

Since middle-market transactions are cash-free and debt-free, buyers typically focus on EV as the starting point before adjusting for working capital and other post-closing adjustments.

Equity Value (Seller’s Net Proceeds)

Equity value represents the amount the seller receives at closing, after adjusting for:

• Debt payoffs (loans, credit lines, notes payable)

• Cash retained by the seller

• Working capital adjustments

Formula:

Equity Value=Enterprise Value+Cash−Debt−Other Adjustments

For sellers, equity value is the most important figure, as it determines how much they will actually receive from the sale after all adjustments are made.

2. EBITDA: The Core Profitability Metric

Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is the most commonly used metric in middle-market M&A for valuation purposes. It reflects the company’s operating profitability before non-operational expenses.

Formula:

EBITDA=Net Income+Interest+Taxes+Depreciation+Amortization

Why EBITDA Matters in M&A

• Used as the basis for valuation multiples (e.g., 5x EBITDA)

• Allows for comparison across companies by neutralizing differences in financing and tax structures

• Helps buyers understand the true operating cash flow

Adjusted EBITDA

Since middle-market businesses often have one-time expenses, owner benefits, or non-recurring costs, buyers typically calculate Adjusted EBITDA, which removes:

• Owner’s salary and discretionary expenses

• One-time legal or restructuring costs

• Non-operating income or expenses

A higher Adjusted EBITDA can result in a higher valuation multiple, increasing the seller’s proceeds.

3. Working Capital Peg: A Key Post-Closing Adjustment

A working capital peg is a critical component of M&A transactions, ensuring the business has enough current assets to sustain operations after closing. Buyers expect the company to maintain a normalized level of working capital so they don’t have to inject additional cash post-closing.

Formula:

Working Capital=Current Assets−Current Liabilities

How the Working Capital Peg Impacts the Final Purchase Price

• If actual working capital at closing is below the peg, the seller owes the buyer the difference.

• If actual working capital at closing exceeds the peg, the seller receives the excess amount.

Since transactions are cash-free, debt-free, working capital is one of the few balance sheet items transferred to the buyer, making it a key negotiation point.

Best Practices for Sellers

• Ensure accounts receivable and inventory levels are accurately reported.

• Avoid aggressive cost-cutting before closing, which could lower working capital and trigger negative adjustments.

• Work with an investment banker to negotiate a fair working capital peg that aligns with historical averages.

4. The Role of M&A Adjustments in Final Purchase Price

Beyond the working capital peg, buyers and sellers must negotiate several other adjustments that affect the final purchase price.

Common Adjustments in Middle-Market M&A

• Earnouts – Contingent payments based on future performance.

• Seller Notes – Deferred payments from the buyer to the seller.

• Debt-Like Items – Adjustments for deferred revenue, lease obligations, or unfunded pension liabilities.

Understanding these adjustments ensures sellers receive fair value and avoid unexpected deductions at closing.

Final Thoughts

For business owners considering an M&A transaction, mastering enterprise value, equity value, EBITDA, and working capital adjustments is critical to maximizing sale price and negotiating favorable terms.

William & Wall specializes in investment banking, corporate valuation, and M&A advisory for business owners in Arizona, Scottsdale, and Phoenix. If you are considering selling your business, contact us today to ensure you get the best possible deal.