Driving deal confidence: The impact of quality of earnings (QoE) analysis in due diligence

In 2023, buyers became increasingly meticulous in their diligence efforts for potential transactions, demanding higher levels of detail. With buyers' risk tolerance at an all-time low, advisors must diligently prepare clients for due diligence to avoid deal delays or failures, as time remains a critical factor for success.

An independent, third-party accountant’s quality of earnings (QoE) analysis in compliance with GAAP/IFRS standards helps align buyer’s expectations and facilitates a smoother transaction. Proactively identifying issues before engaging with buyers allows organisations time to rectify issues or manage seller expectations in advance. Buyers typically uncover issues at a stage where sellers have diminished negotiating leverage, underscoring the importance of internal diligence across various aspects such as human resources, environmental, commercial, and financial. 

It is far more challenging for clients to understand why an issue popped up in a buy-side QoE. It also erodes confidence. Conducting a sell-side QoE analysis minimises surprises, as the advisor has an accountant who can uncover issues and educate clients on how the buy-side will view financial results. 

This helps the seller maintain control of a deal’s financial narrative. Rather than being blindsided by an issue arising from a buy-side QoE, which then forces a defence strategy and rationale to preserve value. A QoE allows the seller to be on the offense, a much stronger position. 

Investment in a QoE analysis offers several advantages in a transaction. A QoE:

1. Demonstrates seriousness to potential buyers, enhancing bid credibility and signalling commitment to a structured process. Buyers focus resources on deals they feel will get done. A QoE provides assurance that the financial results forming the valuation basis are reasonable and less likely to dramatically change during diligence. This assurance can help streamline the buyer's due diligence, minimising redundant analyses and accelerating overall due diligence.
   
   
2. Provides the seller’s advisors with a counterpoint of view during negotiations, effectively leveraging the QoE results to address subjective accounting interpretations. This advocacy strengthens the seller's position and can be used strategically to favourably position issues upfront.
   
   
3. Facilitates the identification and validation of financial adjustments, including add-backs and pro-forma adjustments, which enhance the credibility of the presented financial data. A third-party assessment lends authenticity to these adjustments and places the investment banker in a stronger position during negotiations, bolstering the seller's credibility.

Investing in a quality of earnings analysis not only prepares clients for due diligence but also enhances bid credibility, facilitates negotiations, and strengthens the overall transaction process – a strategic power play.

Rajesh U. Kothari draws on over 30 years of experience as an investor, financial advisor, and entrepreneur. Rajesh is the founder and a managing director of Cascade Partners, a private investment and investment banking firm where he assists companies with mergers, acquisitions, divestitures, restructurings, and other corporate finance activities.