A founder walks into an investor meeting with a deck showing Rs 12 crore of EBITDA on Rs 80 crore of revenue. The 15% margin looks healthy. The growth trajectory shows 25% year-on-year. The valuation ask is 8x EBITDA, which prices the business at Rs 96 crore.
The investor’s analyst spends two hours with the financial statements. The next meeting opens differently. The investor’s first question is not about the product, the market or the team. The investor’s first question is: “Your EBITDA includes Rs 1.8 crore of other income that appears to be non-recurring, Rs 90 lakh of costs classified as exceptional that look like they recur every year, and the promoter’s remuneration is Rs 12 lakh, which is materially below what a replacement CEO would cost. What is the EBITDA if we normalise for these items?”
The normalised EBITDA is not Rs 12 crore. It is Rs 8.4 crore. At 8x, the valuation is Rs 67 crore, not Rs 96 crore. The founder’s Rs 96 crore expectation has dropped by Rs 29 crore before the negotiation has started.
This is not an adversarial tactic. This is standard investor due diligence. Every sophisticated investor (PE fund, strategic acquirer, family office, institutional lender) evaluates EBITDA quality before committing capital. Founders who understand the evaluation and prepare for it negotiate from a position of knowledge. Founders who do not understand it negotiate from a position of surprise.
Question 1: Is the EBITDA sustainable?
Sustainability means the earnings can be expected to continue at a similar level under normal business conditions. The investor tests sustainability by examining:
Non-recurring income. Insurance claims, asset sale gains, litigation settlements, government incentives with a defined expiry, one-time contract revenues. Each is real income. None is expected to recur at the same level. The investor excludes non-recurring income from the sustainable EBITDA.
Recurring costs classified as exceptional. Companies routinely classify restructuring costs, severance payments, write-offs and settlement costs as “exceptional” or “one-time.” If the same category of cost appears in three of the last four years, the investor reclassifies it as recurring. A Rs 60 lakh “restructuring cost” that appears every year is not exceptional. It is a cost of operating the business.
Promoter remuneration. In Indian founder-led businesses, the promoter often draws a below-market salary (Rs 12 lakh to Rs 24 lakh per year for a CEO-equivalent role). The investor normalises by replacing the actual remuneration with the market-rate cost of a professional CEO (Rs 60 lakh to Rs 1.2 crore, depending on the size and complexity of the business). The normalisation reduces EBITDA by the difference.
Related-party transactions. The business rents its factory from the promoter’s family trust at Rs 8 lakh per month. The market rent for a comparable property is Rs 5 lakh. The investor adjusts the EBITDA upward by Rs 36 lakh (the excess rent that would not exist under arm’s length terms). Conversely, if the business purchases raw materials from the promoter’s other company at below-market prices, the investor adjusts the EBITDA downward (the artificially low input cost would normalise post-acquisition when the related-party supply arrangement is renegotiated or terminated).
Question 2: Does revenue translate into cash?
EBITDA measures operating profit before non-cash charges. It does not measure how much of the operating profit converts into cash. The conversion depends on:
Receivable collection. Revenue of Rs 80 crore with receivable days of 90 means Rs 20 crore is locked in receivables at any given time. If the receivable days are increasing (from 60 to 90 over two years), the business is generating revenue faster than it is collecting cash. The growth consumes cash rather than producing it.
Customer concentration. If 40% of revenue comes from a single customer, the investor assesses the customer’s creditworthiness, the contract’s renewal terms and the risk of the customer reducing its purchases. Concentrated revenue is less sustainable than diversified revenue, and the investor may apply a lower multiple.
Working capital intensity. A business that requires Rs 25 crore of working capital to generate Rs 80 crore of revenue has a working capital intensity of 31%. Every Rs 10 crore of revenue growth requires approximately Rs 3.1 crore of additional working capital. The investor models the working capital requirement and subtracts it from the free cash flow available for distribution or reinvestment.
Question 3: Are the accounting numbers reliable?
The investor’s analyst reviews the financial statements for:
Revenue recognition. Is revenue recognised on delivery, on invoicing, on percentage of completion or on some other basis? Is the basis consistent across periods? Has the basis changed (a change from delivery-based to invoicing-based recognition accelerates revenue and flatters the P&L). Are there significant credit notes or returns in the first quarter of the following year (indicating revenue pulled forward to meet the prior year’s target)?
Cut-off accuracy. Are expenses recorded in the period they relate to, or are current-year expenses deferred to the next year (understating this year’s costs and overstating EBITDA)? Are revenue invoices raised in the correct period, or are future-period sales recorded in the current year?
Provisions and estimates. Are provisions for bad debts, warranties, litigation and employee obligations adequate? An underprovided balance sheet flatters the EBITDA by not recognising costs that will eventually materialise.
Consistency. Have the accounting policies, classifications and reporting formats been consistent over the periods being analysed? Changes in classification (reclassifying a cost from cost of goods sold to administrative expenses) can create the appearance of margin improvement without any operational change.
Question 4: Can the business finance its growth?
EBITDA is a measure of operating profit, not a measure of cash available for growth. The cash available for growth is EBITDA minus: capital expenditure (maintenance capex to sustain the current operations plus growth capex to expand), interest payments, tax payments, working capital requirements for the incremental revenue and any debt repayment obligations.
A business with Rs 12 crore of EBITDA, Rs 3 crore of maintenance capex, Rs 2 crore of interest, Rs 2.5 crore of tax and Rs 3 crore of incremental working capital for the projected growth has Rs 1.5 crore of free cash flow. The Rs 12 crore EBITDA headline disguises the fact that the business generates only Rs 1.5 crore of discretionary cash after funding its obligations and its growth.
The investor evaluates whether the business can self-fund its growth or whether the capital being raised is needed to cover the gap between the EBITDA and the cash the business actually produces.
Question 5: Do the forecasts withstand scrutiny?
The founder’s deck projects 25% revenue growth for the next three years. The investor tests the projection against:
Historical performance. If the business grew at 12% per year for the last three years, the 25% projection requires an explanation: a new product, a new market, a capacity expansion, a pricing change. The explanation must be supported by evidence (a signed contract, a completed factory, a launched product), not by aspiration.
Margin assumptions. The forecast shows margins improving from 15% to 20% over three years. The improvement requires either revenue growth without proportional cost growth (operating leverage) or cost reduction. The investor asks which costs are expected to decline, whether the decline is realistic given the business’s cost structure and whether the pricing assumptions hold in a competitive market.
Use of funds. The founder is raising Rs 30 crore. The use-of-funds statement shows Rs 15 crore for capacity expansion, Rs 8 crore for working capital and Rs 7 crore for marketing and team building. The investor evaluates whether the allocations are realistic (is Rs 15 crore enough for the planned expansion?), whether the working capital estimate is consistent with the projected revenue growth and whether the marketing spend will produce the customer acquisition the revenue forecast assumes.
What a founder should prepare
Before entering an investor conversation, the founder should have ready:
Reconciled financial statements for the last three years (audited, not draft). Monthly management accounts for the last 12 months. A receivable ageing by customer (current, 30, 60, 90, 120-plus days). An inventory ageing by product category. A debt schedule showing every borrowing, its terms, its repayment schedule and any covenants. A related-party transaction summary covering every transaction with entities connected to the promoter. A normalised EBITDA bridge (starting with reported EBITDA, showing each adjustment and arriving at the normalised number). A cash conversion analysis (EBITDA to operating cash flow to free cash flow). A forecast model with explicit assumptions that the founder can defend.
The founder who presents these before the investor asks for them demonstrates financial maturity. The founder who scrambles to produce them after the investor’s analyst requests them demonstrates that the financial function is not ready for institutional capital.
Northrop Management advises founders and management teams on capital readiness, financial reporting improvement, EBITDA normalisation and the financial preparation required before institutional fundraising, strategic investment or a potential exit.
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