Benefits of a Sell-Side Quality of Earnings Report
Selling a business can be a very emotional and overwhelming process. It carries a lot of weight, not only on the business owner, but on employees and relatives as well.
There can be a lot of uncertainty in this typically “once-in-a-lifetime” event, but with the right plan and the right team, the process can be much smoother, shorter and beneficial. Oftentimes, a business owner has much of their net worth tied to the business itself, which is why the sale process should not be left to chance, and every opportunity to anticipate and plan for potential detractors of value should be taken.
As part of this process, a Quality of Earnings study (QOE) can be very helpful. It is more than just a financial “snapshot” and can serve as a financial roadmap presenting the earnings and financial position of the company in a more normalized way, which is how a potential acquiror would view the business.
It can also provide a to-do list of actionable items that can prepare the seller for an easier and more rewarding exit. Addressing the issues ahead of the actual sale also relieves additional stress by knowing that any lingering concerns were addressed.
The QOE is an investment that typically rewards the proactive seller. We estimate that a QOE can return up to 4-to-1 on the initial investment if utilized correctly!*
Here are a few reasons to consider a QOE when selling a business.
1. Exit Mindset and Readiness
As Rocky Balboa once said, “The toughest opponent you’re ever going to have to face is in the mirror.” An unprepared fighter won’t stand a chance, and it may ring true too with exiting a business. It can be exhausting, and many have, unfortunately, thrown in the towel because they weren’t ready to commit to the exit process.
Getting a QOE is like training before stepping into the ring. The seller will want to be able to navigate the process and know what will be thrown at them. Not only does it mentally prepare the seller, but it also helps the support staff and management team with the transition as they prepare documents and answer questions.
With a QOE, the seller has an opportunity to correct discrepancies, develop explanations and analyses, and get an honest look at their business from an outsider’s perspective. Knowing the ins and outs of your financial results is critical to a successful outcome.
2. Avoid Costly Delays
Time kills deals. It is not just a motto within the mergers and acquisitions community; it is a legitimate cause and effect. In our experience, one delay typically leads to another delay, and as this domino effect occurs, more questions arise. The last thing a seller needs is to hit snags that cause the buyer to pause, reconsider, renegotiate and possibly walk away.
There is typically a 60-to-90-day window to close a transaction after a Letter of Intent (LOI) is signed. By having done all the preparatory work, there is a higher likelihood of closing on time with fewer bumps and lumps along the way. With all the information already collected, efficiency will be on the seller’s side and the pendulum begins to swing in their favor.
3. Tax Planning
Tax planning isn’t just about what Uncle Sam’s cut of the sale will be; it is also about making sure there are no material tax exposures. Employee Retention Credits (ERC) and sales tax deficiencies have become very common deal issues that need to be addressed in addition to others.
Being able to identify and address potential tax risks, remediate any exposures and confirm historical tax compliance reduces pitfalls in the sale process. Issues that aren’t addressed before talking to buyers tend to pop-up during their due diligence process that may delay or, ultimately, kill a deal.
Tax planning also helps a seller anticipate the after-tax proceeds, which gives them a leg up in negotiating a deal. This also is a helpful exercise in the exit planning stage because then the seller can consider what their “next chapter” is going to be and ensure the proceeds align with the needs and wants in the future.
Far too often, when we are engaged by the buyer to diligence a business, we find the business owner did not perform the proper planning and expected much more take-home proceeds than the deal they negotiated and signed off on. This is a highly emotional situation that typically doesn’t end well, which is not how either party would have designed it. Plus, if there are ways to ensure a seller can shield more of their proceeds, a seller should take advantage of planning ahead and not risk taking home much less.
Should a deal be structured as a sale of company stock or assets? Will there be equity rolling over after the transaction or does the seller want 100% buyout? Weighing all options and understanding the tax implications of each before signing an LOI is beneficial, and it should be discussed with the transaction advisory tax team.
4. Team Support
Whether going through a process with an investment banker or selling directly to a strategic or sponsor group, a seller can have a certain peace of mind knowing that a transaction advisory team is on their side and has performed due diligence with an independent, objective perspective. The team will approach the deal with a level head and stand by their work, with no outside pressure.
Besides asking for relevant documentation and asking insightful questions that can help situate the seller for a more successful exit, the team’s work verifies EBITDA (earnings before interest, taxes, depreciation and amortization) and minimizes the risk of post-closing working capital disputes through their findings.
5. Solidifying Value
One of the primary advantages of a QOE report is the value drivers identified during the due diligence process by having identified add-backs and net working capital adjustments. Choosing to forgo a sell-side QOE report and instead relying solely on the buyer’s QOE can be risky.
Buyers are likely to emphasize only the negative addbacks, which can drive the purchase price down. With the sell-side QOE, the adjusted EBITDA will be clear, and documentation will have been accumulated to support each one.
These adjustments vary from personal expenses, one-time expenses, one-time events (e.g., COVID) and normalization for growth strategies. With the QOE, it improves a seller’s negotiating leverage, reducing the ability for a buyer to push back on the numbers.
6. Defensible Position
There is power in knowing that you’re surrounded by a team of professionals who have performed the due diligence and can defend the numbers. A seller who will likely only go through one sale is very inexperienced in defending their numbers compared to buyers who are doing multiple deals a year.
When the buyer’s due diligence team looks for any discrepancies, they’ll have a difficult time disproving the figures provided by the sell-side QOE. The seller is in a stronger position to answer any questions that may arise by the acquiror. The expected valuation, backed by the QOE, will be justified and should lead to a smoother exit with less strings attached.
Ultimately, the QOE eliminates surprises that can reduce the purchase price or kill the deal.
7. Attract Right Buyers
A sell-side QOE will make it much easier to weed out buyers that are looking for an easy deal. Opportunists will have a more difficult time competing against serious bidders that are attracted to a serious seller.
By deciding to complete a QOE, the seller’s commitment to close the deal is evident, as is their preparedness. With more offers on the table, it will be easier to pick out the best offers with the best suitors to carry the seller’s legacy forward.
Learn More About the Benefits of a Sell-Side Quality of Earnings Report
All the benefits listed point to a key takeaway; being prepared will streamline the exit process when knowing the ins and outs of the company and its financial results. If you’re interested in learning more about the process, please contact one of our transaction advisory professionals.
*Not all businesses or operations are the same and, as such, we cannot guarantee a 4-to-1 return on a QOE.
