$4.9M of EBITDA, supported at $3.7M
Hospitality & Lodging
A buyer was looking at three franchised select-service hotels in the Upper Midwest — 342 keys, $14.9M of revenue, presented at $4.9M of adjusted EBITDA. Most of the seller's add-backs were reasonable. The gap was in what the presentation left out: an owner who ran the asset management function for nothing and leaves at close, brand-mandated improvement plans with fixed completion dates, and repairs capitalized without a policy. We rebuilt the earnings from source documents rather than from the general ledger.
25%
Reduction to the seller's adjusted EBITDA
$4.4M
Debt-like items absent from the price
WHAT WE DID
Three-year and TTM earnings analysis to USALI, an assessment of every seller add-back, the working capital peg, debt-like items, and ten drafting points for the purchase agreement.
Source-document testing rather than reliance on management accounts: payroll registers, franchise disclosure documents, improvement plan letters, bank statements, STR reports and the night audit summaries.
WHAT CHANGED
Adjusted EBITDA supported at $3.7M against the $4.9M presented
$4,360K of debt-like items identified, none of it showing as debt on the balance sheet
Ten drafting points issued for the buyer's counsel
The situation
A buyer had a portfolio under exclusivity: three franchised select-service hotels across three states in the Upper Midwest, 342 keys, held in separate single-asset entities under common ownership. Revenue for the twelve months to June 2026 was $14.9M, of which 87% came from rooms.
The confidential information memorandum presented adjusted EBITDA of $4.9M — a 33.1% margin. The seller proposed $901K of add-backs against management accounts to get there.
The buyer wanted to know whether $4.9M was a number they could underwrite.
What we found
Adjusted EBITDA on our analysis was $3.7M, a margin of 24.8%. The variance of $1,237K breaks into two parts, and the smaller part is the seller's.
We rejected $209K of the proposed add-backs. Two failed on evidence: a claimed lost-profit figure from a renovation, where the competitive set index held at 96.4% through the works, and management company transition costs that could not be traced to the ledger. The rest of the seller's schedule we accepted.
The larger part, $1,028K, was what the presentation did not show. Two thirds of it sat in three items:
No management fee is borne by the business. The portfolio is self-managed by the owner, who performs the asset and revenue management functions personally and exits at close. No property or asset management fee appears in any period. A buyer without an in-house platform will pay one. Normalized against three third-party agreements for comparable Midwest select-service portfolios at 2.75% to 3.25% of revenue, that is $448K a year.
Government assistance presented as trading revenue. $155K of Employee Retention Credit refunds for 2020 and 2021 payroll periods were credited to other operated department revenue rather than shown separately. It is not trading performance and it will not recur.
Repairs capitalized in error. $201K. Sixty-one items were reclassified across the period. The property had no written capitalization policy and applied thresholds ranging from $500 to $5,000 across the three hotels. Guestroom paint, PTAC servicing and lot patching do not extend asset life.
Four contracted cost increases take effect after the period end and reduce the run-rate by a further $338K — a bound insurance renewal, a housekeeping rate step-up, a franchise royalty increase on license renewal, and an enacted state minimum wage rise. None is a projection. Each derives from a contract executed or a notice issued before the report date. That gives pro forma adjusted EBITDA of $3,365K, a margin of 22.5%.
What sat outside the earnings analysis
Three further matters bore on price rather than on EBITDA.
Committed capital that nobody had priced. Brand-mandated property improvement plans at two of the three assets total $2,530K, with fixed completion dates in December 2027 and June 2028. Neither is discretionary; non-completion gives the franchisor a right to terminate the license, which would in turn accelerate the loan. Together they equal 75% of pro forma adjusted EBITDA. This is committed capital, not growth capital expenditure, and a buyer should not model revenue uplift against it beyond holding the existing rate position.
Revenue with near-term expiry. The top five accounts are 16.8% of revenue, which is unremarkable for a portfolio of this size in secondary markets. The contractual position of two of them is the issue. A rail crew contract at 6.8% of revenue expires in March 2027, was awarded by competitive tender with no right of first refusal, and carries no evidence that a renewal discussion has begun. A wind energy contractor at 2.1% is tied to a single construction project completing in Q4 2026 — demand that does not renew. Together they carry an estimated $585K of EBITDA contribution.
A working capital peg set on one month. Net working capital is structurally negative, as it is for almost every hotel, so a more negative peg favors the buyer. The seller proposed the August 2025 balance of $(398)K, which is the least negative month-end figure in the period and reflects the seasonal peak in group receivables. The twelve-month average is $(542)K. Adjusted for an accrued paid time off liability of $128K that has never been booked, the recommended peg is $(670)K. Setting it on a single favorable month transfers $272K to the seller.
In total we identified $4,360K of debt-like items and purchase price considerations, none of which appears as debt on the balance sheet and none of which, other than the equipment leases, is disclosed in the CIM.
What it meant for the price
On an illustrative 8.0x multiple — used solely to scale the findings, with no view expressed on value — the difference between the seller's presentation and pro forma adjusted EBITDA is worth roughly $12.6M of enterprise value before the debt-like items are taken into account. The debt-like items themselves are 16.2% of the implied enterprise value.
The report closed with ten drafting points for the buyer's counsel: the working capital definition and target, treatment of the improvement plan obligations, franchisor consents and transfer fees, an earn-out or escrow tied to the rail contract renewal rather than a price reduction, a specific indemnity for an open lodging tax exposure, and a transition services arrangement covering the owner's functions for at least ninety days.
What this means for acquirers
The pattern in this portfolio is common in owner-operated businesses and has little to do with hospitality.
An owner performs work the business does not pay for, then adds back the compensation they do take. A buyer cannot both add back the owner's compensation and continue to enjoy the function it paid for. Government assistance, capitalization errors and unrecorded liabilities accumulate in a business with a part-time controller and no documented policy — not because anyone intended it, but because nobody was looking.
The three questions worth asking early on any owner-operated target: what does the owner do that the business will have to buy after close, what obligations are already fixed by contract but absent from the price, and is the working capital target set on a period or a moment.
None of these require a large diligence budget to answer. They require someone to work from the source documents rather than the presentation.
Frequently asked questions
What does a quality of earnings report cover?
A quality of earnings report analyzes whether reported earnings are sustainable and repeatable. It assesses the seller's proposed add-backs, identifies adjustments the seller has not made, sets out the net working capital position and recommends a peg, and lists items a buyer would expect to fund, assume or deduct from the equity price. It is not an audit and expresses no assurance on the financial statements.
Why is adjusted EBITDA usually lower than the seller's number?
Because a seller's presentation is built from what should be added back, and a buyer needs what should be taken out as well. In this example the seller's own add-backs were mostly sound. The gap came from costs the business does not currently bear but will after close, income that is not trading performance, and accounting errors that flattered the result.
What are debt-like items?
Obligations a buyer will have to fund or assume that do not appear as debt on the balance sheet. In this example they included unrecorded accrued paid time off, an under-collected lodging tax exposure with penalties, equipment finance leases, franchise transfer fees triggered by the change of control, brand-mandated improvement plans, and the above-market element of a related-party ground lease.
Is a quality of earnings worth it on a smaller deal?
The findings above scale down. On a $3M to $10M transaction the same three patterns — uncompensated owner functions, committed capital absent from the price, and a favorable working capital peg — routinely account for more than the cost of the work.
Project Kestrel is an illustrative sample prepared by CFOLogic to demonstrate the structure and analytical approach of its quality of earnings work product. The target company is fictitious. All figures, entity names, dates, contracts, source documents and findings have been constructed for illustration and do not represent any actual client, transaction or engagement. Nothing in it constitutes an audit, review or compilation of financial statements and no assurance is expressed or implied.