When a transaction falls apart after a letter of intent (LOI) is signed, other potential investors may question why the deal failed. From that point forward, the target company may be viewed as damaged goods.

A significant amount of time, effort, and expense goes into preparing for and conducting a sale process. A failed transaction may cost a seller months of work and risk having to re-enter the market under entirely different economic conditions.

A sell-side Quality of Earnings (QoE) analysis helps minimize the risk of a failed transaction by providing a transparent and defensible deliverable, preemptively identifying potential issues, and allowing the sell-side team to more efficiently move through the buyside diligence process.

Minimize the Risk of a Broken Deal with Supportable Financials

When a company’s financial statements are presented consistent with GAAP and its proposed EBITDA adjustments are fully supported, the risk of a failed transaction or post-LOI price re-trade is reduced.

Software and services companies often unknowingly deviate from GAAP in areas such as:

  • Revenue (and expense) recognition for various revenue streams, including:
      • Hosted subscriptions,
      • On-premises subscriptions,
      • Transactional revenue,
      • Implementation fees,
      • Payment residuals, and
      • Professional services;
  • Payroll and expense cutoff;
  • Sales commission expense recognition;
  • Research and development recognition;
  • Deferred and accrued revenue; and
  • Bad debt expense and allowance for doubtful accounts.

A sell-side QoE should identify and address these issues and make the necessary adjustments to present financial information consistent with GAAP.  A quality sell-side QoE will also analyze non-GAAP metrics that are important to investors.

In a sell-side QoE, the diligence team scrutinizes management’s proposed EBITDA adjustments and supports valid adjustments with general ledger detail and other documentation. As a result, the buyer and its advisors are more likely to accept those EBITDA adjustments during buyside diligence.

Neither the buyer nor the seller wants to encounter unexpected issues with reported financials midway through the transaction process. Having confidence that the company’s financials will withstand buyer scrutiny provides valuable peace of mind and reduces the likelihood of surprises after the process begins.

Maximize the Efficiency of Buyer Diligence

Once the QoE-adjusted financials are complete, sell-side QoE deliverables can significantly streamline and shorten the buyer’s diligence process.

High-quality deliverables should include fully integrated, formula-driven Excel databooks rather than hardcoded schedules. These databooks allow prospective investors and their advisors to drill down from summary outputs to the underlying general ledger detail, enabling them to answer their own questions efficiently and independently.

Management also benefits from completing the sell side QoE process in advance. The Management team can leverage both the QoE deliverables and the experience and knowledge gained during the sell-side QoE process when responding to buyer questions.

An experienced sell-side QoE team will also participate in and help management and its advisors prepare for buyer diligence calls.  The QoE team should be ready and willing to respond to questions and reference the supporting analyses included in the QoE deliverables.

Conclusion

By presenting financial information in an organized, transparent, and fully supported deliverable, a sell-side QoE can accelerate the transaction process and reduce the burden on management.

Ultimately, a high-quality sell-side QoE strengthens the seller’s negotiating position, increases buyer confidence, and improves the likelihood of successfully completing buyer diligence and closing the transaction.