Our EBITDA looks healthy at four million dollars, but buyers are cutting their valuation multiple because we spend forty percent of our cash flow on recurring equipment and software capex. Why do buyers discount high-capex businesses despite strong EBITDA, and how do we defend our true free cash flow?

Question

Tyler Smith · Accepted Answer

Buyers buy cash flow, not theoretical EBITDA. If your business produces four million dollars in EBITDA but consumes 1.6 million dollars annually in recurring equipment purchases, vehicle fleet replacements, or mandatory proprietary software development, your true free cash flow is 2.4 million dollars. That represents a sixty percent cash conversion rate.

Private equity sponsors and financial buyers model their returns using leveraged buyouts. Senior lenders calculate debt capacity based on free cash flow after maintenance capital expenditures, not gross EBITDA. When high capex shrinks debt service capacity, the buyer must contribute more expensive equity, which automatically lowers the multiple they can offer.

To defend your valuation, you must clearly distinguish between maintenance capex and growth capex in your financial reporting. Maintenance capex keeps the current machine running at existing capacity. Growth capex expands capacity to capture new market share. Buyers will penalize you for maintenance capex, but growth capex can be defended as discretionary investment that a future owner could throttle.

Use your quarterly Level 10 Meeting agendas to establish clear capex governance. Have your finance seat maintain a granular asset register that tracks the useful life, maintenance history, and utilization rate of all capitalized investments. If you can prove that forty percent of your historical equipment purchases were offensive investments to onboard specific new customer lines rather than routine replacements, you can justify adding that capital back to discretionary cash flow and preserving your baseline multiple.