We are tempted to cut capital expenditures and technology upgrades over the next two years to maximize our reported EBITDA before selling. Why does this backfire during institutional due diligence?

Question

Tyler Smith · Accepted Answer

Starving capital expenditures and technology investments to artificially juice short-term EBITDA is a novice mistake that institutional buyers spot immediately. While eliminating equipment maintenance, software upgrades, or infrastructure investment may temporarily boost reported operating margins on paper, private equity sponsors and their Quality of Earnings advisors analyze historical capital spend down to the dollar.

During financial diligence, the buyer calculates maintenance capital expenditures, which represents the minimum ongoing capital required to sustain your current business operations. If they see your capital spending fell significantly below historical averages or industry benchmarks in the two years leading up to the sale, they will conclude you deferred necessary reinvestment.

The consequences of this finding are severe:
- The buyer will reclassify your deferred maintenance as a direct deduction from your purchase price or adjust their net working capital target accordingly.
- They will normalize your historical EBITDA downward by adding back the missed capital expenses, which reduces the baseline valuation multiple applied to the transaction.
- Diligence teams will scrutinize your entire operational infrastructure, assuming that if you cut corners on visible physical or software assets, you likely cut corners on compliance, talent, and maintenance.

Instead of starving operations, maintain disciplined, prudent capital investments on your runway. Deploy modern operational tools, automate bottlenecks, and keep equipment in prime operating condition. Buyers willingly pay full multiples for modernized, efficient operations that do not require an immediate capital injection on day one.