Quality of Earnings (QoE) - What is it? Why is it worth it? Who should be ordering one?

A business valuation is a key starting point in mergers and acquisitions (M&A). While it doesn't dictate the final price, it establishes a foundation before market dynamics and other factors enter the picture. However, sophisticated buyers increasingly look beyond a static valuation for financial clarity.

Sellers, particularly those with larger businesses that may lack audited financials, can use a Quality of Earnings (QoE) report prepared for them as a significant marketing tool before engaging with a buyer. 

Here are some key points in favor of a seller ordering a QoE:

Counters buyer skepticism: Unlike a seller’s valuation, which can be perceived as subjective, a QoE report provides an independent and detailed look at the financials. This can help counter buyer skepticism, especially since sophisticated buyers often don't take seller-provided valuations at face value and conduct their internal analysis.

Prevents last-minute price reductions: A QoE report can identify potential red flags such as inconsistent revenue streams, one-time expenses, or potential cash flow issues before they become negotiation sticking points. Addressing these issues upfront helps avoid price reductions or deal retrades later.

Closing the expectation gap: Deals often stall when buyers and sellers perceive the business's value differently. A QoE report can act as a bridge by reinforcing the financial numbers with objective analysis, keeping negotiations on track.

Builds buyer confidence: Buyers, especially institutional investors and private equity firms, rely on a QoE report's granular level of detail. This can demonstrate whether the earnings are reliable and justify the multiple they are willing to pay.

Saves transaction expenses and reduces deal fatigue: By proactively addressing potential financial concerns and fostering buyer confidence, a seller-prepared QoE report can contribute to smoother negotiations and reduce the likelihood of failed transactions. This can ultimately save on transaction expenses and prevent deal fatigue.

In conclusion, while a business valuation is a crucial starting point in the M&A process, a seller-initiated QoE report can act as a powerful marketing tool, providing data-backed insights that build buyer confidence, reduce the risk of deal re-trades, and ultimately help get deals across the finish line. The increasing prevalence of QoE reports even in smaller deals underscores their growing importance in providing financial clarity and facilitating successful transactions