The Quality of Earnings Report: Why It’s Become the Center of the M&A Process

Twenty years ago, the buy-side quality of earnings report was a relatively narrow exercise — a buyer’s accounting firm coming in late in diligence to validate a few EBITDA add-backs and confirm that the financial statements were reliable. Today, the QofE is something different. It is the document around which the deal is negotiated, the source of the EBITDA number that becomes the basis for the price, and the analytical foundation that almost every other workstream — financial diligence, working capital negotiation, earnout structuring — leans on.

And in the past several years, the QofE has migrated from a buyer-side document to a seller-side one as well. Sell-side QofEs are now common to the point of being expected in most middle-market processes. Founders preparing to sell their businesses need to understand why.

What a QofE actually covers

A QofE is broader than a financial statement audit and narrower than a full due diligence review. Its job is to answer a specific set of questions about the company’s reported earnings:

• Are the reported financial results reliable, and prepared on a consistent basis?
• What is the sustainable, normalized EBITDA — adjusted for one-time items, non-recurring expenses, owner compensation above market, and similar items?
• What are the underlying revenue trends — by customer, by product line, by geography — and what do they say about the durability of the business?
• What are the cost trends, and which costs are likely to scale, stay flat, or grow with the business?
• Is the working capital position consistent with the operating needs of the business?
• Are there any accounting issues, exposures, or unusual practices that would affect the way a buyer should value the business?

The output is typically a detailed report — often a hundred pages or more — supported by a structured Excel model that lets users adjust assumptions and see the impact on EBITDA.

Why EBITDA add-backs are the heart of the document

Most middle-market M&A deals are priced as a multiple of EBITDA. The single most important number in the deal is the EBITDA the parties agree to use. And EBITDA, as reported in financial statements, is rarely the same as the EBITDA the parties use to price the deal.

Owner-operated businesses typically run a series of expenses through the company that would not exist under different ownership — above-market owner salaries, family members on payroll, personal vehicles, country club memberships, travel that mixes business and personal. Beyond owner compensation, most businesses also have one-time expenses in any given year — a legal matter that has since resolved, a system implementation, a failed initiative, severance for a departure. None of these expenses will exist for the buyer.

Add-backs adjust EBITDA upward for these items. A well-documented set of add-backs can move EBITDA by ten, twenty, or thirty percent — which, at a typical multiple, can move the deal price by tens of millions of dollars. The QofE is where add-backs get analyzed, supported, and ultimately accepted or rejected.

Every add-back is a negotiation. The QofE is the document that decides which negotiations the seller wins.

The case for a sell-side QofE

Sell-side QofEs were rare a decade ago. They are nearly standard now. The reasons:

Add-backs surface on the seller’s terms

When the buyer’s QofE is the first analytical look at EBITDA, every add-back is something the seller is asking the buyer to accept. When the sell-side QofE comes first, the add-backs are already documented, supported, and built into the EBITDA number being marketed. The buyer’s QofE is then reviewing the seller’s work rather than building its own. The starting point of the negotiation is the seller’s number, not zero.

Surprises happen before the deal, not during

Every business has issues a careful financial review will surface — revenue recognition timing, customer concentration concerns, expenses that look unusual on closer inspection. Sellers want to know about those issues before going to market, not in the middle of an exclusive negotiation with a single buyer. A sell-side QofE surfaces them in time to address them — through documentation, through normalization, through preemptive explanation in the marketing materials.

Process speed and certainty

Buyers running their own QofE need four to eight weeks of access to the company’s financial team. That work happens during the exclusive negotiation window — and it tends to be the workstream that drives the timeline. A sell-side QofE compresses that workstream because the buyer’s team is reviewing existing work rather than building from scratch. Deals close faster, with fewer surprises, with less of the seller’s financial team’s time consumed.

Credibility with sophisticated buyers

Private equity buyers and strategic acquirers with experienced corporate development teams expect a sell-side QofE in any process of meaningful size. A seller who arrives without one signals either inexperience or unwillingness to invest in the process — both of which factor into the buyer’s view of the deal.

When a sell-side QofE may not be worth it

Sell-side QofEs are not universal. The economics work less well in certain situations:

• Very small transactions where the QofE cost is a meaningful percentage of the deal.
• Single-buyer negotiations where the buyer is already in advanced discussions and willing to rely on its own financial review.
• Businesses with very simple, clean financials and minimal add-backs — typically smaller, single-product, owner-operated businesses with limited normalization.

Even in these cases, an abbreviated sell-side financial review — sometimes called a ‘QofE-lite’ — is often worth doing.

What to look for in a QofE provider

Not all QofE providers are the same. The differences matter:

• Transaction-focused experience. A firm that does fifty or one hundred QofEs a year approaches them very differently than a general accounting firm doing a few as a sideline.
• Industry familiarity. QofE providers with experience in the seller’s industry understand the relevant metrics, the common add-back categories, and the issues buyers in that industry will focus on.
• Buyer credibility. Some QofE providers are better known and more trusted by the universe of likely buyers. A QofE from a respected provider gets more deference than the same analysis from an unknown firm.
• Working style. A QofE engagement is intensive and the team will be in close contact with the company’s financial people for a month or more. Fit matters.

What founders should do

If a sale is twelve to twenty-four months out, three steps make sense now:

First, get the financial close process clean. Monthly close. Reliable cutoffs. Clean account reconciliations. A QofE on a messy set of books produces a messy result and an extended timeline. The single best preparation for a future sale is good monthly financial reporting in the years before the sale.

Second, start tracking add-back items as they happen, in real time. Every legal matter, every one-time expense, every above-market compensation item — capture the documentation contemporaneously rather than trying to reconstruct it later. Reconstruction is harder, less defensible, and produces weaker add-backs.

Third, when the time comes, engage the QofE provider before the marketing process starts, not in parallel with it. The QofE work should be complete and the EBITDA number should be defended before the company goes to market. Trying to do both at once compresses the timeline and reduces the quality of both efforts.

The QofE has become the center of the M&A process because the questions it answers — what is the real, sustainable, defensible EBITDA — are the questions on which the deal turns. Sellers who treat it as a central piece of their preparation, not an afterthought, end up in better deals.

Frequently Asked Questions

What is a quality of earnings report in M&A?

A quality of earnings report — usually called a QofE — is a financial analysis prepared by an accounting or transaction advisory firm that assesses the sustainability and reliability of a company’s reported earnings, identifies one-time items, validates revenue and cost trends, and produces a normalized EBITDA figure used as the basis for the deal.

Who prepares the QofE — the buyer or the seller?

Both sides can. Buy-side QofEs have been standard for decades. Sell-side QofEs — prepared by the seller before going to market — have become much more common in the past several years and are now nearly standard in middle-market processes.

How much does a QofE cost?

Pricing varies with the size and complexity of the business but typically runs from forty thousand to one hundred fifty thousand dollars. Larger and more complex businesses, particularly those with multiple legal entities or revenue streams, are at the higher end.

Does a sell-side QofE actually help the seller?

Yes, in most cases. A sell-side QofE lets the seller surface and explain add-backs and normalization adjustments on their own terms, accelerates the buyer’s diligence, reduces the risk of late-stage surprises, and supports a higher and more defensible EBITDA number — which translates to a higher price.

How long does a QofE take to prepare?

Typically four to eight weeks from kickoff, depending on the complexity of the business and the readiness of the financial data. Companies with clean monthly close processes and well-organized financial systems are faster. Companies that close less frequently or have less robust systems take longer.

About the Author

Scott Levine is the Founder and Managing Partner of AEGIS Law, a national law firm built on a fundamentally different model: lawyers focus exclusively on practicing law while a dedicated management team runs the business. Scott has spent nearly thirty years guiding entrepreneurs, founders, and closely held companies through mergers, acquisitions, growth transactions, and exits. He works alongside the firm’s M&A team — including Rochelle Walk, Robert Gold, and others — across AEGIS offices in St. Louis, Chicago, Denver, Tampa Bay, and Southern Illinois. He can be reached through aegislaw.com.