Intercompany Eliminations in Roll-Up Platforms: What Acquirers Find in Diligence and What It Costs

Roll-up platforms operate through multiple legal entities that transact with each other. The transactions create revenue at one entity and expense at another. When properly eliminated at consolidation, the net impact on consolidated EBITDA is zero. When improperly eliminated, the transactions inflate consolidated EBITDA because either the revenue or the expense is captured incompletely.

The distortion mechanisms:

• Management fee inflation. The HoldCo charges operating entities management fees for corporate services (executive time, treasury, legal, HR). The HoldCo recognizes the fee as revenue. The operating entities recognize the fee as expense. If consolidation eliminates the operating entity expense but not the HoldCo revenue, consolidated EBITDA is inflated by the fee amount.
• Shared services allocation errors. Shared services costs (IT, accounting, insurance) are typically allocated across operating entities. If the allocation methodology is inconsistent or if certain entities are undercharged, EBITDA at those entities is artificially inflated. The inflation persists at consolidation if the elimination workpapers do not identify the mispricing.
• Intercompany rent above market. The HoldCo owns real estate leased to operating entities at above-market rates. The operating entities pay the elevated rent as expense. The HoldCo recognizes rent income. Consolidated EBITDA appears normal because the transaction eliminates. However, if the platform is sold and the buyer separates the real estate, the operating entities face market rent that is lower than the elevated intercompany rate, producing higher standalone EBITDA than the seller represented.
• Intercompany loan interest. The HoldCo loans capital to operating entities. Operating entities pay interest to HoldCo. Consolidated interest expense should reflect only external debt. If the intercompany interest is not fully eliminated, consolidated interest is overstated (and consolidated EBITDA is understated below the line). More concerning, entity-level EBITDA at the HoldCo is inflated by the intercompany interest income treated as operating revenue.
• Inventory transfers with margin. One operating entity manufactures products that another operating entity distributes. The transfer occurs at a price that includes margin. The manufacturing entity recognizes the margin as revenue. The distributing entity capitalizes the margin into inventory cost. If consolidation eliminates the transfer but not the margin captured in inventory, consolidated inventory is inflated (and future consolidated EBITDA is understated when the inventory is sold).

FDD teams examining intercompany eliminations follow a specific methodology designed to detect the distortions above. The examination is more forensic than routine QofE because the distortions typically require entity-level analysis rather than consolidated review.

The examination steps:

• Trial balance analysis by entity. The FDD team obtains trial balances for each operating entity plus the HoldCo. Review focuses on revenue and expense accounts that are typical vehicles for intercompany transactions.
• Intercompany account reconciliation. Every entity should have intercompany receivable and payable accounts that reconcile to the counterparty entity. Reconciliation failures indicate elimination errors.
• Related party disclosure review. The FDD team examines related party disclosures in the audited or reviewed financials. Categories to examine include management fees, shared services, intercompany rent, intercompany loans, and inventory transfers.
• Elimination workpaper review. For platforms with audited consolidated financials, the FDD team requests the elimination workpapers. Review focuses on whether the workpapers reconcile revenue and expense eliminations, whether allocation methodologies are consistent, and whether all identified intercompany transactions are captured.
• Entity-level EBITDA calculation. The FDD team calculates EBITDA at each operating entity individually. Comparison to consolidated EBITDA reveals whether the sum of entity EBITDA reconciles to consolidated EBITDA after eliminations.
• Market rate testing. For intercompany rent, management fees, and inventory transfers, the FDD team tests whether pricing reflects market rates. Non-arm's length pricing produces EBITDA distortions that persist across periods.

Management fee and shared services elimination findings translate directly into purchase price adjustments in platform sales. The mechanism is straightforward: the buyer pays for consolidated EBITDA the seller can defend. Eliminations that reduce defensible EBITDA reduce the purchase price at the negotiated multiple.

Above-market intercompany rent and loan interest reveal reporting discipline gaps that extend beyond the specific findings. Platforms that price intercompany transactions at non-arm's length rates typically have broader documentation weaknesses that affect other diligence areas.

The signals:

• Non-arm's length rent pricing. Rent 25 percent or more above market rates indicates either intentional profit-shifting between entities (for tax or reporting purposes) or absence of pricing discipline. Either explanation raises concerns about other related party transactions and about the reliability of entity-level financial statements.
• Circular loan structures. Intercompany loans that flow through multiple entities before returning to the originator suggest structural inefficiency, tax planning that may not survive acquisition, or attempts to defer or accelerate income recognition for specific reporting purposes.
• Inconsistent allocation methodologies. Shared services allocated using different methodologies to different entities suggests the allocations were designed to produce specific entity-level results rather than reflect actual cost consumption. The result is entity-level EBITDA that does not reflect underlying operations.
• Absence of transfer pricing documentation. Multi-entity platforms should maintain transfer pricing documentation for material intercompany transactions. The absence of documentation indicates either that pricing was never formalized or that the platform did not consider the tax and reporting implications.

Buyers encountering these signals typically require:

• Independent transfer pricing study for intercompany transactions
• Restated financials showing intercompany transactions at arm's length
• Additional representation and warranty coverage for intercompany transactions
• Escrow or specific indemnification for tax exposure related to non-arm's length pricing

Acquirers of multi-entity platforms establish elimination frameworks in the first 90 days post-close to prevent the reporting distortions that produced the diligence findings from continuing under new ownership.

Acquirers who establish these frameworks in the first 90 days prevent the intercompany distortions from recurring. Acquirers who defer the framework establishment inherit the distortion patterns and face similar findings on their own eventual exit.