The buy-side Quality of Earnings team has flagged our capitalization of software development costs, claiming it artificially inflates our EBITDA. How do we defend this GAAP accounting practice to preserve our valuation multiple?

Question

Tyler Smith · Accepted Answer

When a buy-side Quality of Earnings team targets your capitalized software development costs, they are trying to force a downward adjustment to your EBITDA by reclassifying capital expenditures as operating expenses. This directly impacts your valuation multiple. To defend your position, you must provide clear documentation that aligns with ASC 350-40 internal-use software capitalization rules. Show them that these capitalized costs are not routine maintenance or operational support. Instead, present your product roadmap, milestone achievements, and developer hour logs to prove this capital went directly into creating new proprietary functionality that generates distinct future economic benefits. Use your V/TO, or Vision/Traction Organizer, to show how these development efforts map to your long-term strategic plans and revenue-producing capabilities. If they continue to push back, suggest a compromise structure where a portion of the software capitalization is validated by an independent technical audit. Alternatively, you can propose a structural adjustment where a portion of the purchase price is tied to the software performing at a specific gross margin or subscription run-rate post-close. This protects your enterprise value while giving the buyer the risk mitigation they seek. Do not let them treat a legitimate balance sheet asset as a simple operating expense without a fight.