If you are preparing to sell a company with an enterprise value north of $10M, you likely already have a relationship with a CPA firm that performs an annual audit. You might assume that a “clean” audit opinion is the gold standard for a buyer’s due diligence.
In the world of sophisticated M&A, however, an audit is merely the entry fee. The actual game is played through a Quality of Earnings (QofE) report.
While an audit looks backward to ensure your numbers comply with GAAP (Generally Accepted Accounting Principles), a QofE looks forward to determine if those numbers are durable, recurring, and representative of the future. An audit tells a buyer that the money was spent; a QofE tells them if the money will come back next year.
The Fundamental Mismatch: Net Income vs. Adjusted EBITDA
Audits are designed for regulators and tax authorities. They focus on Net Income. M&A transactions are designed for investors and lenders. They focus on Adjusted EBITDA.
The delta between these two figures is where millions of dollars in valuation are often won or lost. A QofE specialist “bridges” this gap by identifying three distinct types of adjustments that an auditor would typically ignore:
-
The “Out-of-Period” Correction: Audits are snapshots of a fiscal year. A QofE analyzes monthly trends to ensure that a massive December contract isn’t masking a failing third quarter.
-
Standardization of Owner Discretion: An auditor verifies that your Ferrari lease was recorded as a business expense. A QofE specialist “adds it back” to the earnings, correctly identifying it as a personal benefit that won’t exist under new ownership.
-
Pro-Forma Adjustments: This is where the real value lies. If you hired a new sales VP six months ago who doubled your pipeline, an audit only shows the six months of increased salary cost. A QofE “annualizes” that impact, showing the buyer what the business looks like with that talent in place for a full year.
Why Buyers Demand a QofE (And Why You Should Get One First)
For a Private Equity group or a strategic acquirer, the QofE is their insurance policy. It uncovers the “skeletons” that an audit misses—such as high customer concentration or “revenue recognition” aggressive tactics used to inflate year-end numbers.
At David Mayfair, we strongly advise a Sell-Side QofE before going to market. By commissioning your own report 6 to 12 months before a sale, you achieve two things:
-
Control the Narrative: You identify the “add-backs” first, rather than letting the buyer’s accountants “chip away” at your price during the final days of due diligence.
-
Remove Friction: A pre-vetted QofE from a reputable firm signals to the market that your company is “Institutional Grade.” It can shave 30 to 60 days off the closing timeline.
An audit proves you aren’t lying about the past. A Quality of Earnings report proves you are telling the truth about the future.
