What a quality of earnings report can do to your deal

Somewhere after the LOI is signed, the buyer hires an accounting firm to go through your numbers. That work product is the quality of earnings report — the QofE — and for a lot of owners it's the first unfamiliar thing in the process that has real teeth.

I'm going to stay high-level here, because the mechanics deserve their own article. But you should understand what it is and what it can do.

It is not an audit

An audit asks whether your financial statements were prepared correctly. A QofE asks a different question: what does this business actually earn, and how much of that is likely to keep happening?

So the accountants go looking for the difference between reported earnings and sustainable earnings. Your addbacks get tested one at a time. Owner compensation, the truck, the family member on payroll, the rent you pay yourself for the building, the one-time items you called one-time. Some of those survive. Some don't. They also look at where the revenue comes from and whether it holds up — recurring work versus one-off jobs, customer concentration, margin trends.

For a contractor, the harder territory is usually work in process, percentage-of-completion accounting, retainage, and whether job costing is accurate enough to tell the buyer what any of it means.

One Texas note: since there's no state income tax here, the entity-level filing they'll reconcile your books against is your franchise tax report. If the story your internal financials tell doesn't match the story your filings tell, expect to spend time explaining the gap.

The part owners underestimate

Here's the thing to actually take away.

Your price is almost certainly a multiple of EBITDA. Which means an adjustment to EBITDA does not cost you the adjustment. It costs you the adjustment times the multiple.

If the QofE disallows $150,000 of addbacks and your deal is priced at five times, that's not a $150,000 problem. That's $750,000 off your purchase price.

Owners look at a list of accounting adjustments and see accounting. Buyers look at the same list and see price. The multiplier is why a QofE finding that seems technical and small can move more money than any single term you negotiated.

And price isn't the only thing it moves

A QofE gives the buyer something they didn't have before: an independent-looking document supporting a change in terms. That's a different negotiating posture than "we'd like to pay less."

It can move your working capital peg, since the QofE often produces the analysis that sets it. It can move deal structure rather than price — a buyer citing uncertainty in the numbers may leave the headline figure alone and shift money out of cash at closing and into an earnout or a larger holdback. And it can move the temperature of the whole transaction if it turns up something you didn't disclose, because at that point the argument stops being about a number.

All of this arrives while you're in exclusivity, months in, with your team distracted and your alternatives gone.

The short version

The QofE is where your financial story gets tested by people who do this for a living and are being paid by the other side.

You cannot control what they conclude. You can control whether your books can withstand the look — which is one more reason the preparation work starts a year or two before you go to market, not after somebody asks.