When a buyer is trying to understand what they’re actually paying for, reported earnings rarely tell the whole story. A quality of earnings (QoE) analysis is how acquirers examine whether a company’s profitability is real, repeatable, and likely to hold up after close.
Sellers typically lead with EBITDA, and for good reason: it’s the most common valuation anchor in valuations. But reported EBITDA can mask one-time items, owner-specific expenses, customer retention issues or accounting treatments that will change under new ownership and more stringent reporting requirements. The QoE normalizes those figures to reveal what the business actually earns.
Why Does QoE Matter in M&A Transactions?
Financial statements alone don’t tell you whether revenue was pulled forward, whether margins reflect related-party arrangements, or whether a spike in profitability is structural or the result of non-GAAP accounting. A meaningful QoE engagement is built around those questions, not borrowed from a template.
For buyers, catching these issues early changes the shape of a deal: sometimes the price, sometimes the terms, sometimes the decision to walk. For sellers who commission their own QoE before going to market, it can eliminate the most common sources of renegotiation and build credibility with prospective buyers.
What Role Does QoE Play in Search Fund Acquisition?
Search fund acquisitions tend to involve businesses where the financials are owner-managed, inconsistent, and rarely prepared with a future buyer in mind. That’s not a criticism; it’s just the nature of founder-run companies. It does mean that QoE work often turns up more than it would in a more institutionalized deal.
For a searcher, the stakes are unusually high: they’re evaluating whether a single business can support acquisition debt, pay a reasonable salary and still generate attractive returns. The QoE analysis is how we stress-test that thesis by validating whether historical cash flow is real, understanding capital requirements and deciding whether the deal structure makes sense given what the numbers actually show.
Buyer Takeaways
- Validate whether the business can support acquisition debt.
- Understand whether historical cash flow is real and sustainable.
- Identify capital requirements that may affect returns after close.
- Use the QoE findings to determine whether the proposed deal structure makes sense.
Seller Takeaways
- Understand what a search fund buyer will likely evaluate during diligence.
- Identify financial issues that could create concern before a buyer finds them.
- Present a clearer picture of normalized earnings and business performance.
- Reduce the risk of renegotiation tied to cash flow, working capital or accounting adjustments.
Search Fund Takeaway: For search fund entrepreneurs, the QoE is more than a diligence exercise. It helps determine whether the business can support the full acquisition thesis, including debt service, owner compensation, future growth and the transition from founder-led operations to new ownership.
How Can QoE Support Search Fund Value Creation?
The QoE is often framed as a risk mitigation tool, and it is. But findings often point in both directions. Normalized margins sometimes look consistent than reported ones. Revenue that seemed lumpy turns out to have a recurring core.
Some of the most consequential QofE findings have nothing to do with EBITDA at all. Working capital analysis can reveal whether the business has been systematically under-or over-funded, and highlight cash cycle inefficiencies. The QofE can surface whether the seller has deferred maintenance in ways that will hit the new owner immediately. Balance sheet scrutiny can expose contingent liabilities, customer deposit obligations or off-balance-sheet arrangements that don’t show up in any earnings figure. And a close look at revenue concentration can reframe the entire risk profile of a deal, regardless of what the income statement says.
These findings shape more than valuation. They inform how a searcher structures the deal, what representations and warranties to prioritize and whether the business is actually ready to support the transition they’re planning.
How Can Accounting Advisors Support Your Search Fund Acquisition?
For a deeper look at how accounting firms support search fund entrepreneurs at every stage, the white paper Exploring the Role Accounting Firms Play in a Search Fund Project is an essential resource. Authored by Boulay’s Ryan Turbes, CPA and Clay Brownlee, CPA, in collaboration with A.J. Wasserstein, it offers a comprehensive view of how accounting firms drive value throughout the search fund lifecycle.