When an acquirer commissions a buy-side Quality of Earnings report, what specific accounting adjustments consistently catch owners off guard and erode our negotiated enterprise value?

Question

Tyler Smith · Accepted Answer

A letter of intent states an agreed valuation, but the Quality of Earnings (QofE) report determines how much of that cash actually arrives at closing. Buy-side accounting teams do not audit compliance; their sole mandate is to scrutinize your historical EBITDA, eliminate one-time gains, and identify recurring expenses that you improperly capitalized or omitted.

Four specific adjustments consistently blindside owners and destroy deal value:

The first is normalized compensation for open seats. If an owner, family member, or departing executive worked eighty hours a week while taking an artificially low market salary, the QofE team will inject a market-rate executive compensation expense. That single adjustment reduces adjusted EBITDA and instantly knocks millions off your purchase price.

The second is out-of-period revenue and expense matching. If your team records vendor software bills or annual insurance premiums on a cash disbursement schedule instead of amortizing them across twelve months, the QofE accountant will restate your trailing twelve-month earnings, creating negative EBITDA adjustments.

The third is capital expenditure reclassification. Owners frequently book software subscriptions, internal software development labor, or facility maintenance as capital expenditures to make operational EBITDA look robust. Institutional diligence teams routinely reverse these line items back into operating expenses.

The fourth is customer concentration and bad debt allowances. If you carry aged accounts receivable beyond ninety days without realistic reserve allowances, the QofE team will write them off directly against your balance sheet and adjust your working capital peg.

To prevent these adjustments from blowing up your transaction, commission your own sell-side Quality of Earnings report twelve months before market launch. Identify and defend every historical adjustment before the buyer's accountants arrive.