Surviving a Buy-Side Quality of Earnings Review
A quality of earnings review isn't an audit, and treating it like one is a common mistake sellers make. A buyer's QofE team isn't checking whether your financial statements follow GAAP; they're checking whether your adjusted EBITDA actually reflects what the business will earn once it's theirs, and whether your working capital target is honest.
Here's what typically survives that scrutiny, what gets stripped back out, and how to have your own documentation ready before the buyer's team asks for it.
What a QofE actually tests, and what it doesn't
A quality of earnings review starts from your GAAP-basis financials but isn't itself an audit opinion on whether those financials comply with GAAP. It's an analysis of whether your reported EBITDA, once adjusted for one-time items and normalized for how the business will actually run going forward, represents a sustainable earnings level a buyer can underwrite a price against. That distinction matters because a company can have clean, unqualified financial statements and still get its adjusted EBITDA challenged hard in a QofE, if the addbacks behind that adjusted number don't hold up.
The addbacks that survive scrutiny, and the ones that don't
Addbacks with contemporaneous documentation and a clear one-time story tend to survive: a specific legal settlement with an invoice trail, an owner's compensation adjusted to a documented market rate with actual comparable data behind it, a genuinely non-recurring bad debt write-off tied to a specific customer event. Addbacks that get stripped back out tend to share a pattern: recurring costs relabeled as one-time because they happened to spike in one year, addbacks with no supporting documentation beyond a spreadsheet line, or owner compensation adjustments that assume a replacement manager would cost far less than the market actually pays. A buyer's team has seen every version of an aggressive addback before, so building a case around one rarely survives contact with their own analysis.
Net working capital: the number that decides your purchase price adjustment
The net working capital target, commonly called the peg, sets the baseline your actual working capital at closing gets compared against, with the difference adjusting the purchase price dollar for dollar in either direction. Sellers sometimes push for a peg based on an unusually low historical period, which inflates proceeds at signing but invites a dispute once the buyer's team runs the same trailing average calculation you'd expect them to run. A peg built from a representative trailing period, not a cherry-picked low month, is the one that actually holds up through closing instead of becoming a post-closing argument.
Revenue quality: what buyers' own team will dig into
Beyond the EBITDA addbacks, a QofE team looks hard at whether your revenue is actually as recurring and diversified as it appears in a headline growth number. Customer concentration that isn't disclosed upfront, one-time or non-recurring revenue events folded into what looks like run-rate, and churn trends that a simple year-over-year comparison hides are the kinds of things that come out during this review, usually to your disadvantage if the buyer's team finds them before you've explained them. Surfacing these issues yourself, with context, in your own materials generally lands better than having a buyer's analyst discover them independently.
Building your own documentation file before the buyer's team asks
Pull general ledger detail supporting every addback you plan to claim, not just the summary total, along with any invoices, settlement agreements, or comparable compensation data behind them. Pull customer-level revenue detail covering at least a couple of years, so concentration and churn questions have a ready answer instead of a scramble. And pull the historical monthly working capital detail behind whatever peg you're proposing, so you can show the calculation rather than just assert the number. A file built before diligence starts moves faster and reads as more credible than one assembled in response to each new data request, and it gives your own advisors time to push back on a weak addback before a buyer's team does it for you, in front of the buyer.
Assemble this file before the buyer's team asks for it:
- General ledger detail behind every addback you plan to claim, plus the invoices, settlement agreements or comparable compensation data that support each one.
- Customer-level revenue detail covering at least a couple of years, so concentration and churn questions have ready answers.
- Historical monthly working capital figures, so you can defend a net working capital target based on a representative period rather than a single low month.
- A short written explanation of the one-time nature of each addback, since contemporaneous documentation is what separates addbacks that hold from those that get stripped out.
What Good Looks Like
Every EBITDA addback and the working capital peg are backed by contemporaneous documentation before diligence starts, not assembled after a buyer's team asks the question.
Building The Capability (5-Stage Skill Ladder)
How to Get Started
Frequently Asked Questions
What's the difference between a quality of earnings review and an audit?
An audit tests whether financial statements comply with GAAP and results in an opinion on that compliance. A quality of earnings review tests whether your adjusted EBITDA and working capital actually reflect a sustainable, ongoing business, which is a different question a buyer asks to decide what to pay, not whether your books follow the rules.
Which addbacks typically get rejected by a buyer's diligence team?
Recurring costs relabeled as one-time because they spiked in a single year, addbacks without a documented paper trail, and owner compensation adjustments that assume an unrealistically cheap replacement manager are the ones that get challenged most often. Documentation is what separates an addback that holds from one that gets stripped back out.
How is the net working capital target usually set?
Most deals base it on a trailing historical average over a representative period, not a single cherry-picked low month. A peg based on an unusually low period tends to invite a dispute once the buyer's team recalculates it against a more typical trailing average, which is the comparison you should expect them to run.
Should I run my own quality of earnings review before going to market?
It's often worth it, especially if you plan to claim any meaningful addbacks. A sell-side QofE lets you find and document the weak spots in your own numbers before a buyer's team finds them independently, and it gives you a documented, credible starting point for the negotiation instead of a defensive one.
About the numbers
This guide doesn't quote a sourced benchmark. Figures in it are estimates or general guidance, so check them against your own numbers.
Related Guides
Quality of Earnings Report: What Sellers Should Expect and Prepare
What a quality of earnings review tests, how buy-side and sell-side reports differ, how add-backs and the working capital peg move price, and how to prepare.
Surviving a State Department of Revenue Audit
The audit methodology is often more negotiable than the assessment it produces. Here's the state tax audit process end to end, and when to push back.
Form 1120: Building Your Book-to-Tax Bridge
A worked walkthrough of reconciling book income to taxable income on Form 1120, including the differences that trip up finance teams every year.
Preparing for an IRS ERC Examination
What the IRS actually asks for when it examines an Employee Retention Credit claim, and the documentation gap that trips up most companies that claimed it.
Sales Tax Audits in California, New York and Texas
What makes a sales tax audit in California, New York or Texas different, and the records you need ready before an auditor's letter arrives.
How Long to Keep Corporate Tax and Audit Records
A practical records retention schedule for tax and audit documents, why the real minimum is longer than people assume, and how to actually enforce it.