What is a Quality of Earnings Review?
While much of the sale transaction process is unknown to business owners before launching a sale of their company, perhaps the most unfamiliar step is the Quality of Earnings Review, or Q of E. Ordered from a third-party accounting firm by the buyer, a Q of E confirms the accuracy of the company’s financial statements and highlights any deviations from generally accepted accounting principles (GAAP). The Q of E serves to double-check a buyer’s analysis of the company and helps to normalize the company’s data, and the deliverable consists of both an Excel workbook and a written report, which can be as long as 50 to 60 pages.
Typically, a Q of E is run after a letter of intent is signed, during the post-LOI due diligence phase. Because of the timing, from a seller’s perspective it may feel indistinguishable from the due diligence a buyer is performing, apart from who is asking for the data. Often there is a lot of overlap in the data the third-party accounting firm needs to compile the Q of E and the data a buyer is asking for to run their own analysis. Some new requests (not typically included in a buyer’s request list) can include invoices, receipts, or other analyses to substantiate various EBITDA addbacks.
Similar to the advice we give regarding due diligence, during the Q of E you should be prepared for the amount of data that will be requested from you about the company and have it easily accessible. Depending on the way your company is structured, most of the requests will be directed to your CFO, or perhaps an outside CPA who handles the company’s books.
While ordering a Q of E is standard for most buyers, it is actually required by most lenders if any debt is being used to fund part of the transaction. For larger transactions (companies with $10M in EBITDA, for example), it’s becoming more common for sellers to order a sell-side Q of E as part of a formal auction process. Your investment banker would likely coordinate, but the purpose of the sell-side Q of E is the same – to normalize and confirm your company’s data prior to going to market.
