Quality of Earnings: What It Is and Why It Matters
A Quality of Earnings (QoE) report is an independent financial analysis commissioned to verify and validate the EBITDA of a business being sold. It is a standard requirement in US mid-market M&A and increasingly common in European transactions. For sellers, understanding what a QoE involves — and whether to commission a sell-side version before going to market — is one of the most important process decisions.
What a QoE report does
A QoE report is prepared by an independent accounting firm and assesses the quality and sustainability of a business's earnings. It goes beyond audited financial statements to analyse: the normalisation schedule and the legitimacy of every EBITDA add-back; whether revenue is correctly recognised; the recurring vs. one-time nature of revenue and costs; working capital dynamics and the normalised working capital requirement; any off-balance-sheet liabilities; and the reliability of management's financial reporting. The output is an independently prepared normalised EBITDA figure that the buyer can use as the basis for valuation — rather than relying on management's own analysis.
Who commissions a QoE and when
In most mid-market transactions, the buyer commissions the QoE as part of their due diligence — typically after signing a Letter of Intent (LOI). However, sellers increasingly commission a sell-side QoE before going to market. A sell-side QoE is prepared by an accounting firm engaged by the seller and shared with potential buyers as part of the process materials. It signals preparedness, reduces buyer uncertainty, and can accelerate the deal timeline by giving buyers a head start on financial diligence.
What QoE accountants look for
The areas of most intensive QoE scrutiny include: revenue recognition practices (particularly whether revenue is recognised at the point of performance delivery or at invoicing); the legitimacy and documentation of EBITDA add-backs; customer concentration risk and the recurrence of revenue from key customers; any related-party transactions; contingent liabilities not on the balance sheet; and management's ability to explain variances and provide supporting documentation. Surprises in any of these areas — discovered mid-diligence — are one of the most common causes of deal re-pricing or failure.
The sell-side QoE decision
For businesses above €10M EBITDA (or $10M in the US), investing in a sell-side QoE before going to market is almost always worthwhile. The cost — typically £50,000–£150,000 depending on business complexity — is small relative to the value it protects. A clean sell-side QoE allows you to: negotiate from a stronger position on the normalised EBITDA; avoid late-stage deal re-pricing when the buyer's QoE finds issues you did not surface; run a faster process because buyer financial diligence starts from a verified base; and demonstrate the preparedness and sophistication that institutional buyers expect from a well-run process.
What happens when the QoE finds issues
A well-prepared QoE will surface issues — that is its purpose. The question is whether those issues are surfaced pre-LOI (by a sell-side QoE you control) or post-LOI (by the buyer's QoE, which gives you no control over how they are presented). Issues discovered by a seller's own QoE can be addressed, explained, or appropriately disclosed before engaging buyers. Issues discovered by a buyer's QoE mid-process are presented to you as problems — and typically lead to price reductions, structural changes, or both.
Key takeaways
A QoE report independently validates the normalised EBITDA of a business — it is a standard requirement in US mid-market M&A.
Buyers commission buy-side QoEs as part of due diligence; sellers can commission sell-side QoEs before going to market.
A sell-side QoE is highly recommended for businesses above €10M EBITDA — the cost is small relative to the deal value it protects.
QoE accountants scrutinise add-backs, revenue recognition, customer concentration, and off-balance-sheet liabilities.
Issues found by the buyer's QoE mid-process give the seller no control; issues surfaced by a sell-side QoE can be addressed before engaging buyers.
Related M&A terms
Continue building your M&A knowledge with these related guides.
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