Chapter 10 - Valuation II: Judgment and Adjustments

G2G Chapter 10 - Valuation II: Judgment and Adjustments

Judgment and Adjustments

Valuation II: The Art of the Bridge CHAPTER 10 OF 13 City of London Haircut sits in the Skarn office on a Monday morning. Coffee black, cooling in a glass. An SBCI envelope arrives by courier: thick, glossy, 47 pages. Le Pitch's seal on the front. "Project Forge: Comprehensive Financial Analysis." Haircut "Tell me what matters in a 47-page pitchbook." Associate (off-page) "All of it, obviously." Haircut "Wrong." He opens to page 3: company overview. Scans. Page 7: market analysis. Skim. Page 12: financial statements. Read. Page 31: adjustments and working capital. Study. The rest slides into the bin. Every page after that is comfort. Comfort is expensive. Comfort is why SBCI's fees are higher than anyone else's, and why half their pitchbooks end up in recycling. Haircut "The bridge doesn't tie." Associate "I'll ask SBCI to recheck." Haircut "Don't ask. It never does on the first pass. The question is whether it's sloppiness or strategy. Call them. Ask about the adjustments on page 31. Every one. I want to know who approved each line." By the end of Chapter 9, you will know why the adjustments matter more than the pitch, and why the bridge never ties on the first pass. 01 Adjusted EBITDA in Practice The fundamental valuation metric in PE is not reported EBITDA. It is adjusted EBITDA. Three words. Enormous impact. The Adjustment Framework Reported EBITDA + One-off items = Base Adjusted EBITDA + Run-rate savings = Pro Forma Adjusted EBITDA Königshof FY24 From Reported to Adjusted EBITDA Item €m Type Reported EBITDA 15.9 Baseline Abusive related-party rent (FY23) +0.8 One-off CEO severance (FY24, replacement hired) +1.2 One-off Factory relocation costs +0.6 One-off Base Adjusted 18.5 COO will cut €1.5m admin costs (FY25+) +1.5 Run-rate Pro Forma Adjusted EBITDA 20.0

Buyer's case The story: Reported €15.9m looks modest. But strip one-offs and add achievable cost saves, and the "real" earning power is €20m. That is the number SBCI puts on page 31. That is the number buyers focus on. That is the number the valuation is built from. Adjusted EBITDA is the battleground. Every addback is an argument. Every argument is a negotiation. The question is not "how much did you make?" but "how much could you make?" 02 The Adjustment Spectrum Quality of Earnings Check Three Zones of Credibility Green: Clear Documented one-offs Non-recurring by definition Auditor-approved Examples: severance, legal settlements, asset sales Amber: Judgment Arguably non-recurring Depends on management Requires assumption Examples: consulting projects, one-time IT spend Red: Fiction Recurring costs dressed as one-offs Optimistic assumptions Hard to defend Examples: "always do this" listed as adjustment The sell-side always stacks Green and Amber high, and hopes buyers don't dig into Red. Good financial sponsors dig. They hire QofE (Quality of Earnings) specialists - independent accountants whose job is to mark every adjustment red, then defend Green. QofE Partner (on call) "€1.5m COO savings. Who has signed the employment letter?" Haircut "No one. COO starts Monday." QofE Partner "We're marking it Amber. Achievable, not certain." Haircut "Fair. That's what I told SBCI. They sent it to buyers as Green." Thirty seconds of silence. 03 Enterprise Value to Equity: The Bridge Every M&A deal reduces to one equation. The simplest. The most misunderstood. The Bridge Formula EV + Cash − Debt = Equity EV = what the whole business is worth Equity = what shareholders get The Bridge That Breaks Intuition Königshof €100m EV → ? Equity €m Enterprise Value 100.0 + Cash on hand 40.0