If you are going to market with your business in the next eighteen months, read this carefully.
And if you are buying a mid-market business that has shown strong performance improvement in the two or three years before the sale process began, read it even more carefully.
What I am about to describe is not fraud. It is not illegal. It is not even unusual. It is a pattern of legitimate business behaviour that improves reported financial performance in ways that are entirely real in the short term and that financial due diligence is not well designed to detect. It shows up in owner-managed businesses regularly, sometimes deliberately and sometimes simply because a founder preparing to exit naturally starts making decisions differently.
It looks like a business getting better. Sometimes it is. Often it is a business that has borrowed performance from its own future.
The four patterns
Capex that stopped.
In most operating businesses, there is a level of maintenance capital expenditure that the business needs to spend simply to keep running at its current level. Equipment, systems, vehicles, premises. This is not growth investment. It is the cost of standing still.
In the two to three years before a sale, many owner-managers stop making this investment. Not completely, and not on paper, but the decisions that would normally be made get deferred. The equipment that should have been replaced gets patched. The system upgrade that was overdue gets pushed. The premises refurbishment that the sales team had been asking about for two years gets deprioritised.
None of this appears in the accounts as a problem. Capex falling below historic norms is visible in the numbers, but it looks like efficiency. EBITDA improves because depreciation is understated relative to real economic wear. Free cash flow looks strong because cash that should have been spent was not.
The buyer inherits the deferred liability. It shows up eighteen months after close as an unexpected capital requirement that was not in the acquisition model.
Headcount that was never replaced.
People leave businesses. In a normally functioning organisation, when someone leaves a role that matters, they get replaced. The process takes time, but it happens.
In a business preparing for sale, vacancies sometimes do not get filled. Not all of them, and not obviously. But the operations manager who retired, the two sales people who left for competitors, the finance analyst who moved on, these positions sit open for longer than they would have in normal times. The existing team absorbs the work. Overtime increases, or quality quietly declines, or certain activities simply stop happening.
The effect on reported margins is immediate and flattering. The headcount cost line falls. EBITDA rises. The business looks more efficient than it was twelve months ago.
The buyer models forward from that margin. They do not realise they are modelling from a structurally understaffed base. Within a year of close, the hires that should have been made get made, and the margin that supported the acquisition multiple is no longer there.
Revenue that was pulled forward.
This is the subtlest of the patterns and the hardest to detect without asking the right questions directly.
In most businesses, there is flexibility in the timing of customer commitments. An annual contract renewal can be negotiated early. A customer who was planning to expand their relationship in the following year can be encouraged to commit now with an appropriate incentive. A long-standing customer can be asked to prepay for a service they were going to use anyway.
None of these transactions are artificial. The revenue is real. The customer relationship is real. The commitment is genuine.
But the timing has been influenced. Revenue that would naturally have appeared in year one post-acquisition has been recognised in year two or three pre-acquisition. The growth trend looks better than the underlying commercial momentum actually is. And the buyer, who is paying a multiple of the last twelve months' earnings, is paying a multiple of a number that includes revenue borrowed from their own first year of ownership.
Costs that were cut for the wrong reasons.
Every business has discretionary expenditure that a motivated seller will review before going to market. Marketing spend that was not generating measurable return. Training budgets that felt like nice-to-haves. Professional development costs. Industry association memberships. The sponsorship that the founder supported personally but that the business did not strictly need.
Some of this rationalisation is legitimate and permanent. Good housekeeping that any rigorous owner should have done earlier.
Some of it is not. The marketing spend that was cut had a six to twelve month lag before the pipeline effects became visible. The training budget reduction saves money now and costs margin later as capability atrophies. The relationship costs that were eliminated felt optional until, post-acquisition, the relationships they supported turned out to matter.
The cost base the buyer inherits is not the cost base the business needs to sustain its current revenue trajectory. It is a cost base that was optimised for a snapshot, not for continuity.
Why financial due diligence does not catch this
Quality of earnings analysis, done properly, will catch some of it. A skilled financial due diligence team reviewing normalised EBITDA will identify obvious add-backs and challenge aggressive revenue recognition. They will look at capex trends and may ask questions about deferred maintenance.
But there are limits to what financial analysis can determine from historical numbers alone.
Financial due diligence cannot tell you whether the two vacant positions in the sales team represent a temporary gap or a structural decision. It cannot tell you whether the customer who signed a three-year contract in month eleven before the sale process began was planning to sign that contract anyway or was nudged by an incentive that compressed future revenue into a number the seller needed. It cannot tell you whether the capex trend reflects genuine operational efficiency or deferred liability that will crystallise after close.
These are operational questions. They require conversations with people, observations about how the business actually functions, and the specific experience to recognise patterns that look different from the outside than they feel from the inside.
What this means if you are a buyer
The starting point is not suspicion. Most founders preparing businesses for sale are not acting in bad faith. They are making rational decisions in their own interest, as any seller should. Some of the performance improvement you are looking at is real and sustainable. Some of it is not. The difficulty is that the two look identical in the accounts.
What you need to understand before you price the deal is which you are looking at.
This means asking specific operational questions that go beyond what the financial statements show. What was the maintenance capex run-rate three years ago, and what is it now? Are there open positions in the business, and how long have they been vacant? Which customers made material new or expanded commitments in the eighteen months before the process began, and what was the commercial context for those commitments? Where has discretionary spending been cut, and what was its function?
These questions are not aggressive. They are reasonable. A seller who has genuinely improved the business's performance will have straightforward answers. A business whose recent performance reflects timing and deferral rather than operational improvement will show that too, in the answers and in the gaps between them.
What this means if you are a seller
If you are eighteen months from going to market, the single most important thing you can do is not to optimise the numbers. It is to ensure that the operational reality of the business is consistent with what the numbers show.
The patterns described above are detectable by any buyer who is looking carefully. When they are detected during diligence, the most common outcomes are a reduced valuation, an earn-out structure that puts the performance risk back on you, or a deal that does not close.
The preparation that actually increases your exit value is the kind that is sustainable: building management depth that does not depend on you, formalising commercial relationships that are currently informal, investing in the operational infrastructure that the business genuinely needs, and producing financial performance that a new owner can maintain and build on.
A business that can demonstrate it will perform as well without you as it did with you is worth more than one that cannot. Not because buyers are generous, but because they are pricing the risk of the business they are inheriting, and sustainability is the most valuable thing a seller can demonstrate.
The numbers that went up before the sale will come back down unless the operations that produced them are genuinely stronger. Buyers who have been burned before know how to look. Expect to be looked at carefully.
Diadem Advisory provides operational due diligence for mid-market acquisitions and sell-side readiness assessments for founders preparing for exit. If you want to understand what a buyer will find before they find it, contact us.
This article is intended for general informational purposes only and does not constitute legal, financial, or professional advice. Readers should obtain independent professional advice tailored to their specific circumstances before making any acquisition, investment, or business decision.
This article was researched and written with the assistance of artificial intelligence tools.