The buyer is insisting on a post-closing Quality of Earnings adjustment period to finalize the purchase price based on audited numbers. How do we structure our Letter of Intent to lock in the accounting principles and specific definitions of EBITDA so they cannot use QoE adjustments to retroactively chip away at our multiple?

Question

Tyler Smith · Accepted Answer

A post-closing Quality of Earnings review is a favorite tool of buyers looking to re-trade the deal. If your Letter of Intent simply says the purchase price is a multiple of EBITDA, you are handing the buyer a blank check to redefine your earnings during the diligence phase. They will bring in their auditors to challenge every expense, revenue recognition policy, and inventory valuation method to drive your EBITDA down.

To prevent this, your Letter of Intent must specify the exact accounting principles that will govern the calculation of EBITDA. Do not just agree to generally accepted accounting principles. Instead, state that EBITDA will be calculated consistent with your historical accounting policies, provided they are in accordance with GAAP.

You must also include a detailed, non-exhaustive list of specific adjustments and add-backs in the Letter of Intent. This should cover owner compensation, non-recurring expenses, and any adjustments related to your optimized operating model. By defining these parameters upfront, the buy-side auditors are restricted to verifying your numbers rather than rewriting your accounting rules.

Use your internal finance team to draft this schedule. In your weekly Level 10 Meeting, review these definitions with your fractional CFO or controller. Treat this definition as a critical Rock for the quarter, and do not sign the Letter of Intent until the buyer signs off on this exact framework.