Skipping a Quality of Earnings can feel like saving money. In practice, it’s often the most expensive way to do it. The fee you avoid shows up later as an inflated purchase price, a working-capital miss, or terms you have to unwind after close.
A QoE isn’t a lender checkbox. It’s a practical read on how the business actually makes money, what’s recurring, what’s inflated, and what changes when you own it, so you price the company on reality and set terms that fit the risk.
Below is a straightforward look at what a QoE covers, why it more than pays for itself, and how to use it to negotiate smarter before you sign.
What a QoE actually does
A proper QoE answers four questions that determine valuation and terms.
1) Are earnings real, repeatable, and fairly stated?
It reconciles reported results to bank activity and tests revenue recognition, cut-off, and gross margin logic. It also separates recurring margin from one-offs and timing noise.
2) Which add-backs are legitimate?
It validates owner compensation, personal expenses, and “one-time” items. Then it prices replacement costs you will carry post-close, like a market-rate GM or reinstated marketing.
3) What working capital is truly needed to run the business?
It analyzes AR aging, seasonal inventory needs, and AP practices so you can set a clean peg, add a collar, and avoid funding yesterday’s receivables with tomorrow’s equity.
4) Where are the red flags that change structure?
It highlights customer concentration, contract gaps, sales tax and payroll exposures, and any items best solved with escrows, indemnities, seller notes, or targeted earnouts.
Why skipping QoE is a false economy
The logic for skipping is familiar: “The business is simple.” “The bank will do its own review.” “We need to keep fees low.” Each argument ignores how valuation math works.
Headline math that bites buyers
- Add-back inflation: If Adjusted EBITDA is overstated by $100k and your deal prices at 4×, you just overpaid $400k.
- Working capital miss: A peg set $250k too high is $250k of extra cash out the door at close.
- Customer mix: Losing one 20% customer after close can blow through your DSCR. You pay for that with cash and time, not opinions.
QoE fees vary by scope and size, but in SMB deals they are often a small fraction of the dollars above. You do not need the most expensive provider to get 90% of the benefit.
Five ways a QoE pays for itself
1) Price correction from EBITDA normalization
Disallowed add-backs and timing fixes reduce Adjusted EBITDA. Tie the change directly to enterprise value. If EBITDA drops by $150k and you’re at 3.5×, that is $525k you either save in price or solve with structure.
2) Clean working capital mechanics
A QoE gives you the data to define the peg, set a collar, and agree to a 60-day true-up. You avoid silent overpayment and the post-close tug-of-war that sours relationships.
3) Structure that shares real risk
When the report surfaces concentration or specific exposures, you can use seller notes, holdbacks, or simple, auditable earnouts to align incentives. You are no longer arguing; you are risk-sharing based on documented facts.
4) Smoother financing
Banks underwrite cash flow and covenants. A credible QoE reduces underwriter questions, tightens timelines, and prevents last-minute retrades that force you to renegotiate in a rush.
5) A stronger post-close plan
The same analysis that fixes valuation informs your first 100 days: where gross margin slips, which contracts need attention, what collections habits help or hurt, and which hires matter first.
What a QoE typically uncovers
Add-backs that don’t hold up
Owner perks that require replacement, “non-recurring” legal fees that show up every year, and expense cuts during sale prep that you will need to reinstate.
Revenue recognition gaps
Cash-basis “revenue,” project billings recorded up front, or subscriptions recognized unevenly relative to delivery.
Working capital gaps
Aged receivables propped up by lenient terms, seasonal inventory that the peg ignores, and AP practices that temporarily boost cash but are not sustainable.
Concentration and contract clarity
Dependency on a few customers, at-will agreements with soft assignability, and renewal cliffs that sit inside your first year of ownership.
“But the bank’s diligence will catch that, right?”
No. Lender reviews are designed to protect the lender. They ask, “Can this business service debt under our assumptions?” not “Will you operate this business without heroic effort?” A bank can be comfortable with coverage while you inherit owner-centric operations, brittle processes, or revenue that does not transfer cleanly. Treat bank work as complementary, not a substitute.
How to scope a QoE so it’s fast and useful
You control scope. Calibrate it to the deal rather than running a generic checklist.
Focus on value movers
Direct your provider to concentrate on: revenue quality, add-backs over a set threshold, seasonality and working capital, and any known exposures (sales tax, labor classification, warranty). You do not need forensic depth on pennies that won’t move terms.
Set deliverables and timing up front
Ask for a short “issues list” within the first week, then a focused final report. Early signal lets you reopen terms quickly if needed.
Tie outputs to negotiation
Request clear schedules: seller Adjusted EBITDA vs. validated Adjusted EBITDA, working capital analysis with a recommended peg and collar, and a one-page risk summary with suggested structures. You want exhibits you can drop into an LOI addendum.
How to use a QoE to renegotiate
Make it collaborative and math-first.
Lead with the facts, then offer options
Walk the seller through what changed: normalized EBITDA, peg implications, and any concentration risks. Then present choices that solve the delta: modest price movement, a seller note, an earnout tied to retention or gross profit, and targeted escrows for specific items.
Keep changes proportional
Do not cut price across the board for a single, bounded issue. Solve bounded issues with bounded tools. That keeps goodwill high and increases close probability.
Document it in the LOI
Add clear language: price based on QoE-validated Adjusted EBITDA and a defined working capital methodology; outline the intended peg and collar; note any contemplated seller financing or earnout concepts so no one is surprised later.
A quick example of the math
- Seller markets $1.2M Adjusted EBITDA.
- QoE disallows $180k of add-backs and normalizes revenue timing, moving EBITDA to $1.0M.
- At 3.5×, headline value drops $700k.
- Working capital analysis lowers the peg by $200k and adds a ±$100k collar.
- Concentration review identifies a 24% customer with at-will terms. You keep the revised price, add a $250k seller note, and a $200k earnout tied to gross profit from that account over 12 months.
You have not “won” a negotiation. You have priced reality and shared risk where it lives.
Red flags that make a QoE non-negotiable
- Adjusted EBITDA far above net income with thin documentation.
- At-will contracts for outsized customers.
- Large swings in cash that do not match revenue timing.
- Significant owner perks with no plan to replace the function.
- Deferred revenue or customer deposits that management treats as “just cash.”
- Inventory that turns slowly or shows heavy obsolescence risk.
If two or more show up, a QoE is not optional. It is the cost of not overpaying.
Buyer checklist: get the most from your QoE
- Define the scope around revenue quality, add-backs, and working capital.
- Ask for an early issues list and a concise final report.
- Translate findings into dollars and terms before definitive docs.
- Update your model and debt service calculations with the validated EBITDA.
- Adjust your LOI: price, peg, collar, and any seller note, earnout, or escrow.
- Keep tone cooperative and solution-oriented.
Final word
A Quality of Earnings is not paperwork. It is the cheapest insurance you can buy against paying for profits that never show up. If you treat the QoE as your negotiation blueprint to normalize earnings, set a clean working capital peg, and share real risks with structure, you will save more than you spend, close with confidence, and sleep better on day one of ownership. Skipping it might feel frugal. In practice, it is the most expensive way to save money.
Contact us today or book a free consultation and learn how we can be a trusted partner on your next deal!
