How should we audit and defend our seller discretionary add-backs before commissioning a buy-side or sell-side Quality of Earnings report?

Question

Tyler Smith · Accepted Answer

Every founder believes their personal add-backs are legitimate until an institutional buyer brings in an independent accounting firm for a Quality of Earnings audit. If you attempt to justify personal auto leases, family cell phone plans, aggressive travel, or discretionary bonuses during live diligence without meticulous documentation, buyers will haircut your adjusted EBITDA and downgrade their trust in your balance sheet.

To clean your financials twelve to twenty-four months before entering the market, execute three concrete disciplines:

- Eliminate personal expenses immediately: Stop running lifestyle expenses through the operating entity. Transition personal expenses out of the general ledger now so your trailing twelve months reflect pure, clean operating overhead.

- Document non-recurring professional expenses: If you paid one-time legal fees for a patent defense or hired an outside firm to implement AI operational workflows, compile every invoice, engagement letter, and board approval. Acquirers will allow non-recurring operational adjustments only if the documentation proves the spend will not recur post-close.

- Normalize market-rate executive compensation: If you pay yourself fifty thousand dollars or five hundred thousand dollars, a buyer will adjust your EBITDA to reflect fair market replacement cost for your seat on the Accountability Chart. Commission an independent executive compensation benchmark so you can defend your payroll normalization with third-party data rather than guesswork.

Commissioning your own sell-side Quality of Earnings report six months before market launch gives you the chance to spot and rectify messy ledger items before a hostile buyer uses them against your valuation.