• Michael Shaw

The Value of a Sell-Side Quality of Earnings Report

Updated: Jul 20, 2021

The more prepared a seller is headed into an M&A transaction, the better off they will be. A key piece of this preparation should be a sell-side quality of earnings (QofE) report.

Before going to market, a seller can hire a third party accounting firm to complete an analysis from the perspective of a buyer. These QofE reports usually consist of financial, operational, and working capital trends; nonrecurring items (typical areas of adjustments to reported EBITDA); and risk management issues, among other details.

The QofE report is often detailed in several pages that sit within a broader due diligence report that is completed by certified accountants.

There are many reasons to get a QofE:

QofE Benefits

  • Establishes Credibility

Getting a QofE report establishes credibility with prospective buyers, who appreciate the preparedness of a seller that has completed an independent review and analysis of its financial information. This positions sellers well in a competitive environment.

  • Offers a Practice Run

The QofE process is a dry run of sorts for sellers to be adequately prepared for the high-stakes due diligence phase of a transaction. A seller affords itself the opportunity to address any lingering issues, establish targets and expectations, and avoid any surprises that could pop up during the buyer’s due diligence process.

Furthermore, sellers can make sure they are up to speed with ever-changing accounting standards and anticipate any probing questions a buyer may ask.

  • Explain Non-Recurring Items

A QofE report puts a story to the numbers. By “normalizing” their earnings, a seller can identify necessary adjustments to EBITDA because of non-recurring and unusual items. This provides the buyer with necessary context around their financial documents.

  • Expedited Process

A QofE report helps facilitate an efficient transaction. When an interested buyer signs a letter of intent, the seller can have information ready to allow the buyer to progress smoothly through due diligence.

Potential buyers should have a lot of their questions and concerns addressed in the report and will be able to focus their own due diligence on any extraneous items. Although it will not replace a buyer’s due diligence, a QofE report gives the buyer a clearer path to conduct its own buy-side due diligence.

Worthwhile Investment

Think of a QofE report as an investment in your business.

By committing the resources upfront, sellers can ensure the deal process is fast and efficient, and that it culminates in a successful transaction. Sellers can ensure that adjustments made during negotiations are not only favorable to the buyer but that they also align with the seller’s prior expectations. Indeed, the QofE process not only supports a smooth process but can help maximize the value of a business in a transaction.

Audited financials are not the same as deal financials, which buyers will use to come up with their valuation. When a seller goes to market, they should make a point to tell their own story, identifying operational strengths and adding color beyond the dollars and cents laid out in GAAP financial statements.

No two deals are alike, and that is a good reason to make sure you are well prepared to succeed in your own unique situation.

As you think about working through sell-side due diligence, contact Copper Run to learn more about quality of earnings reports.

Matthew Roberts is Director at Copper Run. He specializes in the business services, distribution, and manufacturing sectors.

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