The buyer's Quality of Earnings firm is attempting to classify our accrued employee bonuses and deferred lease maintenance obligations as debt-like liabilities to reduce our cash at close. How do we use our operational metrics to prove these are normal working capital items?

Question

Tyler Smith · Accepted Answer

Buy side Quality of Earnings firms are paid to find debt-like items. By shifting obligations from net working capital to debt-like liabilities, they dollar-for-dollar reduce the cash you receive at the closing table. You must defend these classifications by demonstrating that these expenses are recurring, normal operational costs.

To protect your valuation, point directly to your historical operating metrics and standard practices. If you have historically paid employee bonuses quarterly based on scorecard performance, and these are budgeted within your normal operating cash flows, they belong in working capital. You should present a multi-year analysis showing that these accruals are a consistent, predictable part of your business cycle.

For deferred maintenance, prove that these costs are routine and captured in your regular operating budgets, not capital expenditures. Use your historical cash flow records to show that these expenses occur regularly to keep operations running.

The best defense is a well-defined net working capital peg in the letter of intent. Specify exactly which balance sheet accounts are included in working capital and which are classified as debt. If you define these definitions early, the Quality of Earnings auditors cannot unilaterally reclassify them during due diligence. Work with your leadership team to prepare a clear bridge analysis that links your daily operating cash requirements to the proposed working capital peg. This keeps the buyer from chip-away tactics at your purchase price.