The Quality of Earnings review is one of the most consequential steps in M&A due diligence, yet most sellers encounter it for the first time after signing a letter of intent. By that point, exclusivity has been granted, other buyers have been told to stand down, and the practical cost of walking away has become real. Every finding the buyer’s QoE team surfaces during that window becomes a basis for renegotiating the price, adjusting deal structure, or shifting financial risk back to the seller.
Sellers who prepare for the QoE before going to market change those dynamics.
| In This Article: What a Quality of Earnings review actually examines, where it most commonly surfaces issues in industrial and services businesses, and why sellers who address these areas before the buyer’s team arrives tend to have materially smoother and better-protected transactions. |
A QoE is Not an Audit, But It May Be Even More Important
Business owners frequently assume that clean financials and tax returns satisfy a buyer’s need for financial verification. They may even point to audited or externally reviewed financials. However, this is not the same. An audit confirms that financial statements comply with GAAP. A QoE examines whether reported earnings are a reliable, sustainable indicator of the business’s ongoing cash flow generation. These are fundamentally different exercises, and a clean audit has never prevented a buyer from conducting their own QoE.
The QoE is typically produced by an independent accounting firm engaged on behalf of the buyer or lender. Its central concern is whether the adjusted EBITDA figure the seller is presenting accurately represents the earnings a new owner can expect going forward. The gap between reported earnings and adjusted EBITDA in the QoE is where the bulk of any post-LOI negotiation in a deal takes place.
Timing Is The Seller’s Greatest Vulnerability
In a standard middle-market transaction, the buyer’s QoE team begins their work after the LOI is signed and exclusivity begins. The seller has stopped marketing the business and other buyers have been told that they lost. Time pressure builds as both parties work within a limited time period to get to a closing.
Financial findings carry different weights depending on when they surface:
Issue found before going to market: The seller can openly discuss the issue with numerous potential buyers, provide mitigating information, actually try to fix the issue (if there’s enough time), and then choose the buyer that most clearly accepts the underlying risk and incorporates it into their LOI.
Issue found by the buyer’s QoE team post-LOI: The seller is in exclusivity with no competitive alternative. Ultimately, the seller’s only real leverage is their ability to walk away from the deal. Both sides know that, and know that it is a sub-optimal outcome for the seller. The seller is motivated to make a deal work with the chosen buyer.
Sellers who do a sell-side QoE before the process launches, or who at minimum conduct a structured internal review against the questions a buyer’s team will ask, shift this balance. With a sell-side QoE, there are fewer potential surprises hidden in the financials. One equally reputable accounting firm is unlikely to miss substantive findings that another might find. The seller is then prepared to go into exclusivity with a sense of comfort in the numbers.
What the Quality of Earnings Examines
A QoE review covers four primary areas. Each one has direct implications for the seller’s final proceeds.
| Area | What the QoE Team Examines | What It Means for the Seller |
| EBITDA adjustments | Documentation, consistency, and logic behind every add-back: owner compensation, personal expenses, one-time costs, non-recurring items. | The standard behind acceptable adjustments is whether the buyer can reasonably expect it won’t repeat. The underlying expenses need to be documented and pro forma assumptions need to be defensible. The question behind every add-back is the same: will the next owner actually see this cash? |
| Revenue quality | Composition of the revenue base: recurring vs. project-based, contracted vs. at-will, customer concentration, and whether any historical revenue reflects conditions unlikely to repeat. | For services businesses where long-standing client relationships drive a meaningful share of revenue, the QoE team will examine contract terms, renewal history, and the extent to which revenue depends on the owner’s personal relationships rather than the broader team. |
| Working capital | Historical patterns across multiple periods to establish a normalized operating level, accounting for seasonality and billing cycles. | Most deals include a working capital peg. If the business delivers less than the target at closing, the shortfall is deducted dollar-for-dollar from proceeds. Sellers who haven’t analyzed their own working capital behavior before the buyer’s team does enter the peg negotiation without an informed position. |
| Debt-like items | Items buyers classify as debt-like even when they don’t appear as formal debt: deferred revenue, unfunded retirement liabilities, warranty reserves, customer deposits, deferred maintenance. | Every purchase agreement defines “Indebtedness”. What is included in this number typically reduces your net take-home amount dollar for dollar. It is normal to have debt. However, there are some items that buyers may claim to be “debt-like” that need to be understood before that definition is negotiated. |
Most Common QoE Issues In Lower Middle Market Services Businesses
Across owner-operated services businesses, a set of issues appears with enough consistency that sellers in those sectors can anticipate them:
- Owner compensation. Most owner-operators are paid in ways that don’t reflect what the business actually needs to spend on labor going forward. The add-back logic is straightforward: remove what the owner was paid, substitute the market cost of replacing the roles they filled. The problem is that “the roles they filled” often requires more analysis than sellers expect. An owner who ran the business, managed the sales team, and handled three major client relationships wasn’t just a CEO. Each function has a market rate, and the add-back needs to reflect that.
- Revenue recognition. The adjustment the buyer’s team will make is to restate the trailing twelve months on a true accrual basis, matching revenue to the period in which work was performed rather than when cash was collected. The biggest impact depends on whether that restatement moves revenue into the TTM window or out of it. A business that collected aggressively in the final months before going to market may find that a portion of that revenue belongs to a prior period. A business that performed significant work late in the TTM but billed on delivery may find the opposite. Either way, the EBITDA the seller has been presenting gets recalculated, and the seller should ideally do that math themselves before the buyer’s team does it for them.
- Capex classification. Equipment-intensive businesses face inquiries about how much reinvestment the business requires to sustain current earnings. When maintenance capex and growth capex are not clearly distinguished in the seller’s records, or the company is overextending the life of old equipment, the buyer’s team may conclude that ongoing “pro forma” cash flow should be reduced.
Prepare Before the Buyer’s Team Arrives
At Roadmap Advisors, preparing clients for the financial scrutiny a buyer’s team will apply is a standard part of our sell-side engagements. Before any buyer has seen the business, we work through the EBITDA adjustments, working capital dynamics, customer concentration profile, and balance sheet items that a QoE team will examine.
In our experience, sellers who have done that work in advance tend to have faster, less contentious diligence periods than those who encounter these questions for the first time after an LOI is signed and the competitive process that generated the offer has ended.
If you want to understand how your financials are likely to be evaluated before you go to market, we welcome the conversation.