PE Is Not Buying EBITDA. It’s Buying Confidence.

Markets do not reward history; they discount uncertainty

“We don’t pay for last year’s EBITDA. We pay for the confidence we can grow next year’s.”

The remark, delivered without theatrics by a mid-market private equity partner, is inelegant but accurate. Multiples are not a reward for past excellence; they are a probability-weighted forecast of future execution. In lower mid-market SMB industrial deals, the real negotiation is not over price but over conviction.

This is why the same company can receive wildly different valuations from different buyers. The spread is not sentiment; it is risk discounting. PitchBook estimates that fewer than three percent of owner-led firms successfully complete a traditional sell-side process, while capital concentration continues to narrow toward funds with scale and confidence in post-close lift.

McKinsey’s study Beyond the Hockey Stick finds that roughly ten percent of firms capture more than eighty percent of total economic value creation over a decade. The distribution is not linear; it is a power law, and private capital prices accordingly. The pricing function is therefore a risk-adjusted forecast: is this company one of the ten percent that can compound, or one of the ninety percent that will merely endure? The buyers that are still deploying are selective, not generous.

Underwriting is the sorting mechanism.

Owners think they are being judged; the risk they absorb is being underwritten

The key misunderstanding among owners in industrial SMB manufacturing is that investors are pricing the business as it exists today. They are not. They are pricing how much of today’s EBITDA will still be standing once the owner leaves the room—and how quickly a buyer can compound it thereafter. A clean P&L does not answer that question. A QoE cannot answer it either. Only the operating system of the company can.

The underwriting sequence is blunt. First: “Is this company durable without the current owner?” Second: “Can we institutionalize what works without overpaying for the privilege?” Third: “Is the growth story credible inside the four walls, not just in the offering memorandum?” The multiple is not a judgment of worth but an output of underwriting: the present value of future net cash flows and terminal value. It is then discounted by the capital injections and execution risk required to achieve them.

Growth is not rewarded; legibility is

In one recent diligence discussion, the room stalled on the simplest of questions: “What business are we actually buying?” The owner had healthy EBITDA, a loyal customer base, and sensible unit economics. The problem was strategic drift. Five initiatives were being pursued at once, each potentially attractive, but none coherent. What looked like optionality to the operator appeared as drift to the buyer. The haircut was not punishment. It was uncertainty, priced.

Bain’s research on adjacency moves in industrial firms finds that more than 70 percent of unfocused expansions underperform their core, not because the markets are unattractive but because the operating system was never built to carry that variety.

This is the quiet truth of lower mid-market industrial underwriting: most valuation erosion is not caused by obvious weaknesses but by ambiguous intentions. Buyers can underwrite a bottleneck in a manufacturing or industrial SMB environment. They can underwrite a thin bench. They can even underwrite cyclicality if there is discipline in cash conversion. What they cannot underwrite is a company without a crisp answer to “why this model, at this scale, with this focus.”

Owner-reliance is therefore not the root concern; it is merely the most visible proxy for something larger: concentration of judgment. When all strategic direction lives in one head, the buyer assumes execution risk remains unpriced. The same dynamic applies to firms with sprawling initiative sets, product creep, or half-adjacent expansions justified only by “customers asked for it.” The fear is not mismanagement. The fear is diffusion.

For investors, confidence is not a feeling; it is infrastructure. It shows up in routinized decisions, reliable reporting cadence, constraint-aware capital allocation, and a recognizably bounded strategy. Growth, in that context, is not a hope but a process, and what many owners call exit readiness is simply the point at which the operating system becomes legible to a buyer. The more predictable the process, the narrower the haircut.

This is why the best offers do not reward scale so much as clarity. A smaller firm with a defensible core and visible path to systematized expansion will often outprice a larger firm with a blurred identity. Size without focus is not resilience. It is leverage without a thesis.

The market’s selectivity is frequently misread as stinginess. It is better understood as underwriting discipline. When capital is choosy, ambiguity is expensive. What is being purchased is not the last twelve months of performance but the institutional momentum of the next thirty-six.

In the end, what is being priced is legibility.

A company easy to read is a company easy to scale.

Originally published on LinkedIn. Updated and republished here with additional insights.