During our Quality of Earnings review, the buyer's advisory firm is trying to recharacterize our regular software licenses and custom AI development costs as ongoing capital expenditures rather than EBITDA add-backs. How do we defend our software-enabled operating costs to keep them from depressing our valuation?

Question

Tyler Smith · Accepted Answer

Quality of Earnings auditors are paid to find reasons to reduce your adjusted EBITDA. One common tactic is recharacterizing operational expenses as capital expenditures, or vice versa, to manipulate your baseline earnings. When you invest in custom AI development or enterprise software licenses, the buy-side firm will argue these are ongoing, maintenance-level capital expenditures that must be deducted from cash flow.

To defend your numbers, you must clearly separate true capitalized development from routine operating expenses. Under GAAP, software development costs can only be capitalized during the application development stage. If your AI investments were one-time upgrades to build proprietary operational workflows, they should be treated as one-time capital investments or non-recurring add-backs, not ongoing maintenance.

Present the auditors with your technical roadmaps and project scopes. Show them that these expenditures had a clear start and end date, designed specifically to build the infrastructure that the new owner will inherit. This is where your Step by Step Exit Business Integrity Review pays off. By documenting your technology architecture and its direct impact on efficiency prior to the audit, you can prove these were strategic, value-enhancing upgrades rather than routine maintenance.

Align your finance seat on your Accountability Chart to lead this defense. Do not let the buyer's accountants dictate the narrative. Provide clean, documented proof that these tech investments have already concluded, leaving the buyer with a highly optimized, low-cost operating model that will drive future margin expansion.