Quality of Earnings (QofE) providers are traditionally brought in on the sell-side when the owners of a company have made the decision to sell the business. During the QofE process, adjustments are made to EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) that will ultimately impact the purchase price of the company.
Business owners can utilize a pre-sale QofE before they put their company on the market to identify and correct issues that affect its value well in advance of a sale. This helps ensure the business owners can put their best foot forward when it’s time to go to market.
“A pre-sale QofE will give companies that lack a robust accounting function a better sense of the company’s profitability,” says Steve Miller, Transaction Advisory Services Senior Manager at Corrigan Krause. “It will convey what the business is really making and what it’s ultimately worth, as well as how to improve the business to maximize value whether a sale is imminent or not.”
Smart Business spoke with Miller about the pre-sale QofE — why and when to use it, and what to expect from the process.
What does the process of a pre-sale QofE look like?
A pre-sale QofE looks a lot like a traditional QofE but is meant to help a seller put their ‘buy-side hat’ on and identify all of the issues that could prevent the business owners from selling their company at maximum value. Because the company isn’t going to market at that moment, it gives the business owners pointed improvements to make, and enough time and runway to make them. It also gives the business owners a trial run at what the sale process is going to look like, so they’re not overwhelmed when the time comes.
The service provider performing the pre-sale QofE generally needs monthly trial balances, payroll by employee, revenue by customer, and certain key balance sheet details such as accounts receivable, accounts payable, inventory or any significant accruals. The process generally looks at the previous two fiscal years and the most recent trailing 12-month period. For businesses that are audited or reviewed, it might be helpful to have conversations with the audit partner.
When should the process take place and how long does it take?
The best time to get a pre-sale QofE is well before the decision is made to exit the business. A common scenario is a founder-owned business where the current generation is approaching retirement age and they are aware the next generation doesn’t want to take over the business when they retire. It’s preferred to have at least a year of runway in advance of the anticipated sale date so the business has a chance to make any recommended improvements and see those improvements materialize.
The process usually takes about a month. The ultimate output will show the seller what their adjusted EBITDA looks like as of today as well as identify action items for the business owner to improve. Then as time goes on, the model can be rolled forward to show how the business has improved from the time the work was initially performed through the most recent date. When the business goes to market, the deal will progress substantially faster to close because the overwhelming majority of the QofE will already be finalized. Additionally, the seller will be prepared to address questions from the buy-side team as these conversations have been going on in the background since the start of the pre-sale QofE.
Who should companies work with to get a pre-sale QofE?
Business owners should ensure they engage transaction advisory specialists that have a dedicated QofE practice and M&A experience. Among the most important traits of a transaction advisory specialist is being responsive around the clock. These deals are often very stressful times in the sellers’ lives. There’s a lot going on during the deal process and the business can’t afford to have its QofE provider be the bottleneck.
Most business owners have never been through a sale before. It’s a time-consuming exercise and it causes a lot of fatigue given the thoroughness of all the parties involved. A pre-sale QofE helps prepare the business owner and their team for the rigorous process of a sale. The more prepared a seller and their company can be when the time comes, the better chance there is of maximizing value in a sale. ●
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