A More Active M&A Market Is Still a More Selective Market

Private equity sponsors and strategic acquirers continue to pursue attractive businesses, but the threshold for conviction has increased. Buyers are placing greater emphasis on recurring and defensible revenue, sustainable margins, customer retention, working capital requirements, and a clear path to post-close value creation.

This creates an important distinction between reported earnings and sustainable earnings.

A business may demonstrate strong historical EBITDA while still carrying risks that become apparent during diligence: aggressive revenue recognition, nonrecurring revenue or expenses, customer concentration, margin volatility, underinvestment in the business, unusual owner-related expenses, or working capital requirements that are not evident from the income statement alone.

In a selective market, these issues can directly influence valuation, deal structure, and ultimately whether a transaction closes.

Historically, some sellers viewed quality of earnings as primarily a confirmatory exercise performed after a buyer was identified. Increasingly, sophisticated sellers and their advisors are addressing these issues before entering the market.

A sell-side quality of earnings analysis can identify potential diligence issues before buyers do, establish support for EBITDA adjustments, analyze revenue and margin trends, and provide a clearer understanding of normalized working capital.

For buyers, financial due diligence serves a complementary purpose. The objective is not simply to validate historical financial statements, but to understand the economics of the business being acquired and determine whether the earnings supporting the purchase price are repeatable after closing.

The current environment does not appear to be a market without capital. It is a market in which capital is increasingly competing for businesses that can demonstrate durable earnings, credible growth, and financial information that withstands scrutiny.

For business owners considering a transaction over the next 12 to 24 months, preparation can therefore begin well before a formal sale process. Understanding normalized EBITDA, revenue quality, customer concentration, margin trends, working capital, and potential debt-like items can help identify issues while there is still time to address them.

For investors, disciplined financial diligence remains equally important. Greater competition for high-quality assets can create pressure to move quickly, but speed should not come at the expense of understanding the underlying earnings and cash flow characteristics of the business.

The takeaway: M&A activity may be improving, but improving markets do not eliminate diligence risk. In many cases, they increase the importance of understanding precisely what is being bought — and what portion of reported performance is likely to continue after the transaction closes.