How to treat government grants and subsidies in FDD: recurring vs one-off support, R&D credits, furlough normalisation, IAS 20 presentation and EBITDA quality.
A target's profit and loss account can look wonderfully healthy right up until you ask a single question: how much of this EBITDA came from the government rather than from customers? Grant income, furlough support, energy subsidies and R&D tax credits have a way of quietly propping up earnings in exactly the periods a vendor wants to present. Some of that support is a durable feature of the business model. A great deal of it is a one-off cheque that will never arrive again. Telling the two apart is one of the more valuable things a diligence analyst does, because a pound of grant income and a pound of customer revenue are not worth the same to a buyer paying a multiple of earnings.
This article covers how to identify grant and subsidy income, how IAS 20 lets management present it (and hide it), how to normalise pandemic-era support, and how the sustainability of grant income feeds the Quality of Earnings conclusion. Grants are a revenue-quality problem dressed up as an accounting-presentation problem, and you need to be fluent in both.
A government grant is assistance from government - national, regional, or supranational - in return for past or future compliance with certain conditions relating to the operating activities of the entity. In practice, on a diligence engagement, you will meet several distinct species, and they do not all behave the same way.
Revenue-based grants subsidise operating costs or income: wage subsidies, energy-cost relief, training grants, regional employment incentives. These land in or near EBITDA and are the ones that most directly distort earnings.
Capital grants fund the purchase of an asset - a subsidised piece of plant, a grant towards a new facility. These sit outside EBITDA (either netted against the asset or released to income over the asset's life) and matter more for maintenance capex and asset-base analysis than for the earnings line.
R&D tax credits are a special and frequently misunderstood case. Depending on the scheme and the accounting policy, a credit may be presented above the line as other income or a reduction in R&D expense (which flatters EBITDA), or below the line within the tax charge (which does not touch EBITDA at all). You cannot treat R&D credits generically; you have to find out where in the P&L they land before you can judge them.
Pandemic and crisis support - furlough or job-retention schemes, business-interruption grants, energy price caps - is almost always non-recurring by design and is the first thing to normalise.
The single most useful question to ask management: "Show me every line in the P&L that would not exist if the government did nothing." The answer is rarely just the line labelled 'grants'.
Here is what makes grants dangerous rather than merely present: IAS 20 Accounting for Government Grants gives management a genuine accounting-policy choice about how to present grants related to income. They may:
Both are permitted. Both are, in isolation, perfectly compliant. But they look completely different to a reader, and the netting option is the one that hides the ball. A £2.0m energy subsidy netted against cost of sales simply makes the gross margin look 2 points better than the underlying business can sustain. There is no "grant income" line to flag it. Unless you go looking, it is invisible.
This is why grant analysis is really an exercise in finding, not just measuring. Your toolkit:
The same instinct drives good revenue-quality work: what matters is not what the label says, but what is economically underneath it.
Consider a manufacturer presenting FY25 adjusted EBITDA of £8.0m. During diligence you identify three streams of government support. Your job is to decide, stream by stream, how much of that £8.0m is sustainable.
| Support stream | Amount in FY25 EBITDA | Recurring? | Adjustment |
|---|---|---|---|
| Reported adjusted EBITDA | £8.0m | - | - |
| COVID job-retention (furlough) | £0.7m | No - scheme closed | Remove £0.7m |
| Temporary energy-cost relief (netted in COGS) | £0.5m | No - scheme expired | Remove £0.5m |
| Ongoing regional employment grant (annual, 5-yr agreement) | £0.4m | Yes - 3 years left, then reviewed | Retain, but flag tail risk |
| Normalised recurring EBITDA | £6.8m | –£1.2m |
The reported £8.0m contains £1.2m of non-recurring government support. Normalised EBITDA is £6.8m - a 15% haircut. At an 8.0x multiple, that £1.2m is worth £9.6m of enterprise value the buyer should not be paying for. The ongoing regional grant of £0.4m stays in, because it is contractual and durable, but you flag that it lapses in three years and its renewal is not guaranteed - a sustainability caveat the buyer needs in the model even though it does not move today's number.
Takeaway: normalising grants is not "add them all back." It is a stream-by-stream judgement about durability. The furlough cheque goes; the five-year regional agreement stays, with a footnote about its tail.
Everything in grant analysis reduces to one question - will this income still be here for the buyer? Three tests help you answer it defensibly.
Is it tied to a temporary policy? Crisis-era support (furlough, energy caps, business-interruption grants) is explicitly time-limited legislation. It is the clearest non-recurring category and should be normalised out with confidence. This is standard run-rate EBITDA discipline: the maintainable figure is what the business earns once the temporary scaffolding is removed.
Is it contractual and durable? A signed multi-year regional development grant, a long-running training subsidy that renews as a matter of course, an R&D credit the company qualifies for every year because R&D is core to what it does - these have a genuine claim to recur. You generally retain them in EBITDA, but you always test the tail: when does the agreement end, and what happens then?
Is it structurally part of the model? Some businesses - renewable energy, agriculture, certain care and education providers - receive subsidy as a permanent feature of their sector economics. Here the grant is arguably as reliable as customer revenue. But it carries a different risk: regulatory and political dependency. A business whose margin depends on a subsidy regime is exposed to that regime changing, and that belongs in the red-flags section even if the income itself is stable.
The R&D credit deserves its own note. If credits are recurring and the company genuinely qualifies each year, they can reasonably stay in the earnings picture - but only if they are presented above the line in the first place, and only if you have confirmed the qualifying activity is ongoing rather than a one-off claim for a historical project. Where the credit sits in the tax line, it never touched EBITDA and the question is moot for the earnings bridge, though it still matters for cash and for the tax-risk workstream.
Grants do not only distort EBITDA; they distort cash and the balance sheet, and a thorough analyst follows the money.
Furlough and support schemes were often received as cash inflows that temporarily flattered operating cash flow and, in some cases, working capital. If a target collected grant cash in the period but the entitlement related to costs already incurred, you may find a grant receivable or deferred grant income sitting on the balance sheet. These need to be understood in the net working capital analysis, because they can inflate the working capital position at the reference date and distort the working capital target if left in the normalised range.
Deferred capital grant balances - the credit side of a capital grant being released over an asset's life - can also look debt-like or provision-like depending on their terms. Whether they belong in the net debt definition is a judgement to raise explicitly rather than assume, and it is exactly the kind of item that gets negotiated in the EV-to-equity bridge. The point is not that grants are always a net debt item; it is that grant-related balances rarely belong quietly in the middle of working capital without someone deciding they should be there.
Some sectors live on public money, and the analysis changes shape accordingly.
In renewables, feed-in tariffs and contracts-for-difference are the revenue model, contracted for years, and are more reliable than most commercial contracts. In agriculture, subsidy has historically been structural. In social care, childcare and further education, a large share of income is effectively government-funded. For these businesses, stripping the subsidy out of EBITDA would be nonsensical - it is the operating economics.
The work here shifts from "is it recurring?" (it is) to "what is the policy risk?" You assess contract length, the political durability of the scheme, any indexation or clawback mechanisms, and concentration on a single funding body - which starts to resemble customer concentration risk, only the customer is the state. A vendor's vendor due diligence report on such a business should address this head-on; if it glosses over policy risk, that is itself a finding.
Grants are a favourite scenario question because they test whether you distinguish accounting presentation from economic substance. A strong answer sounds like this.
"My first move is to find all of it, not just the line called 'grants', because IAS 20 lets management net grants against costs - so a big energy subsidy might be hiding in cost of sales making the margin look better than it is. I'd ask for a full schedule of government assistance by scheme and by P&L line, and cross-check payroll and utility costs. Then I'd split the support into recurring and non-recurring. Pandemic-era furlough and temporary energy relief are non-recurring by design - I'd normalise those out of EBITDA. But something like a contracted multi-year regional employment grant, or a genuinely recurring R&D credit where the company qualifies every year, can stay in, provided I test the tail: when does it end, and what happens then. For R&D credits specifically I'd confirm whether they're above the line or in the tax charge, because if they're in tax they never touched EBITDA. Finally I'd check the balance sheet - grant receivables and deferred grant income can inflate working capital at the reference date, so I'd make sure they're isolated from the working capital peg. The overall point I'd land is that grant income and customer revenue aren't worth the same to a buyer paying a multiple, so the quality of that EBITDA is the real question."
That answer wins because it starts with finding the income, moves to a durability judgement rather than a blanket haircut, and closes on the working capital and quality implications - showing you see the whole balance sheet, not just the P&L.
Government support is generosity with a due-diligence sting: it lifts earnings in exactly the periods a vendor most wants to present, and IAS 20 lets a chunk of it hide inside the cost base. The disciplined approach is to find every pound of it, split it stream by stream into what will survive the sale and what will not, normalise the temporary support out of EBITDA, and follow the cash into working capital and net debt. Retain what is genuinely contractual and durable, but never without documenting its tail and its policy risk.
Ask the question the P&L will not volunteer: how much of this profit came from the government? Until you can answer it precisely, you do not yet know what the business is really worth.
The Transaction Services Interview Programme (€119.99, one-time) includes a focused unit on grant and subsidy analysis - IAS 20 presentation, furlough and energy-support normalisation, R&D credit placement, and the working capital knock-on. Enrol today.
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