Your Quality of Earnings Questions Answered...

Embarking on a merger or acquisition (M&A) journey can be both thrilling and overwhelming for founders and entrepreneurs alike. Amidst the intricate M&A landscape, one critical aspect that often raises questions for entrepreneurs is the quality of earnings analysis. As a founder, you may find yourself unfamiliar with this concept and its role in the M&A process. In this Mergers & Acquisitions Explained Q&A deep dive, we aim to address common questions that founders frequently have about quality of earnings.

By shedding light on this crucial aspect of selling a company, we hope to equip founders and business owners with the knowledge needed to navigate the M&A landscape more confidently. Join us as we delve into the world of quality of earnings and uncover its significance when it comes to selling your business.

As a business owner, can I manage a Quality of Earnings analysis internally with my CFO and finance team, or do I have to go to an accounting firm to support?

It comes down to a question of credibility, and the benefit of having an independent, certified, outside firm managing the process on behalf of the seller. Buyers want a stamp of approval and credibility by an outside firm. Although the firm is working "on behalf" of the seller, they have professional rules that have to be abided by when they put a stamp of approval on a due diligence report. So, there is an important perception from the potential buyer that you went to an professional organization outside of your company to perform an earnings quality report.

Of course, it is always a best practice to do your own work inside the organization when it comes to accounting policies and revenue management - however, there should be a stamp of approval by an external accounting firm via sell side due diligence to put you in the best position to "maximize your exit".

What should I ask when interviewing an accounting firm to create a quality of earnings report on the business?

It is important to ensure that the chosen accounting firm has depth of experience doing due diligence, particularly on the sell side. The firm should be able to disclose (without mentioning names) a number of recent transactions that they participated in, and supported sell side due diligence or a quality of earnings report.

As the saying goes, "time kills all deals", so you should ensure that they have available resources to support your project - if you're unable to get your work done in a proper timeframe because they don't have the proper resources on the ready, you're going to introduce significant risk as you bring your company to market. So so you want to make sure you understand what their traditional timeline looks like.

Additionally, don't be afraid to as for an example of what their traditional QofE deliverables look like. They should have non-confidential reports that they can give you as an example of their work product.

What does it cost to run a Quality of Earnings analysis?

Typically, a quality of earnings report could cost as little as $45,000, and as high as $150,000, with most earnings quality analyses running in the $50,000 to $60,000 range - it ultimately depends on the company size, industry, engagement scope, and the depth of the analysis being created. It is a fair question to ask potential accounting firms to give you an upfront range of potential costs based on what they understand about your company.

What's the time commitment of the company's leadership team or CFO to run a quality of earnings analysis?

It is very likely that the CEO and CFO or Controller will need to be heavily engaged during the lifecycle of the project. As the external accounting firm is likely to be unfamiliar with the business they are analyzing, there is a lot of company-specific knowledge and financial diligence required to get the accounting firm up to speed.

Most firms will take 45-60 days to pull together a high-quality analysis of a companies financials. However, in a complicated industry or extremely large enterprise, 60 to 90 days is not entirely out of the question.

What are the biggest reasons to consider a Quality of Earnings analysis prior to the goal line of an M&A transaction?

1) Credibility - there is no way for your internal finance team to replicate the "credibility" of having an outside accounting firm qualify the accounting practices, revenue, EBITDA, and future potential of your business.

2) With a the benefit of a high-quality Quality of Earnings analysis in your pocket, the purchase price that a buyer puts on the table is far less likely to be contested during due diligence. There are far fewer financial "skeletons" for them to find, and as such, there is less for them to use when trying to negotiate down your ultimate purchase price

3) It can help you avoid painful and expensive representation and warranty ("reps & warranties") oversights after you've sold the business.

Additional Quality of Earnings Resources

For additional information regarding the topic of quality of earnings:

• Cashing Out Podcast: listen to M&A industry experts Todd Sullivan (CEO, Exitwise) and Larry Simon (CPA/Partner, Doeren Mayhew) discussing enterprise value and QofE during a recent Exitwise M&A Live Event and Cashing Out podcast episode.

• Additional Reading: The Importance of Quality of Earnings When Selling Your Business