We capitalized a lot of our software and AI development costs to make our balance sheet look stronger, but our M&A advisors say this will hurt us in due diligence. How do we clean up our treatment of technology capitalization and development expenses to show true operational margins to a buyer?

Question

Tyler Smith · Accepted Answer

Capitalizing software and AI development costs can artificially inflate your EBITDA on paper, but sophisticated buyers will see right through this. During due diligence, their financial analysts will look at these capitalized costs as ongoing maintenance expenses. If they suspect you have been capitalizing normal operational costs to make your margins look better, they will adjust your EBITDA downward and lose trust in your financial reporting.

To fix this on your exit runway, you need to transition your accounting treatment to match standard GAAP practices for technology development. Reclassify routine software maintenance, minor updates, and prompt-engineering labor as operating expenses on your profit and loss statement rather than capital expenditures.

Only capitalize development costs that meet strict criteria for creating entirely new, proprietary, and depreciable software assets. Work with a qualified CPA to document this accounting policy clearly. When you present your financials to potential buyers, show them a clean, historical reconciliation of these expenses.

Showing that you have already normalized these tech development costs builds immense credibility. It proves your margins are real and that your AI operations do not require hidden, ongoing capital injections just to stay afloat.