Quality of Earnings Due Diligence: Buy-Side vs. Sell-Side QoE

A buy-side quality of earnings report and a sell-side quality of earnings report look at the same financial data through opposite lenses. The buy-side report is ordered by the acquirer to confirm whether the target’s earnings are real, recurring, and worth the asking price. The sell-side report is commissioned by the seller to get ahead of buyer scrutiny, validate an adjusted EBITDA figure, and reduce friction during the deal process. Both are forms of quality of earnings due diligence, but their objectives, scope, and outputs diverge in meaningful ways that affect how deals are structured and how they close.

What Quality of Earnings Due Diligence Actually Involves

A quality of earnings (QoE) report is a financial due diligence engagement, not an audit. It does not produce an opinion under generally accepted auditing standards, and it is not governed by the attestation framework that applies to a financial statement audit or to an agreed-upon procedures engagement. A QoE is generally a consulting engagement performed under the AICPA’s Statement on Standards for Consulting Services (SSCS) No. 1, scoped flexibly to the needs of the transaction rather than reported under a standardized attestation format. The AICPA’s Transaction Services resources outline the professional competencies relevant to financial due diligence work of this type.

The core deliverable is an adjusted EBITDA schedule that separates recurring, normalized earnings from non-recurring items, accounting anomalies, and owner-specific costs. That schedule drives valuation in most middle-market transactions, because buyers and lenders apply an EBITDA multiple to arrive at enterprise value. A difference of $500,000 in agreed adjusted EBITDA at an 8x multiple is a $4 million difference in purchase price.

What the Report Covers

A thorough quality of earnings due diligence engagement typically addresses:

• Revenue quality. Are revenues recurring, contractually supported, and recognized in the correct period? Are there customer concentration risks or one-time spikes from non-repeating projects?
• EBITDA add-backs. What adjustments to reported earnings are defensible, and which do not survive scrutiny? Common legitimate add-backs include one-time legal settlements, above-market owner compensation that will not continue under new ownership, and discrete restructuring costs. Recurring expenses dressed up as one-time charges are the most common category that buyers reject.
• Working capital normalization. What is a sustainable level of net working capital, and what should the working capital peg (the target at close) be? Working-capital disputes are one of the most frequent post-closing claim categories in M&A.
• Accounting policy review. Does the company use revenue recognition policies consistent with the applicable accounting framework? Are there reserves, accruals, or deferrals that distort reported results?
• Off-balance-sheet items and debt-like liabilities. Unfunded pension obligations, deferred revenue, customer deposits, and operating lease commitments may not appear on the face of the balance sheet but affect net proceeds.

Buy-Side Quality of Earnings: The Acquirer’s Lens

A buy-side QoE is commissioned by the acquirer, often a private equity firm, a strategic buyer, or a company pursuing an acquisition. Its primary purpose is to protect the buyer from overpaying for earnings that are not real, not repeatable, or not transferable.

What the Buy-Side Advisor Is Looking For

The buy-side team approaches the target’s financials with professional skepticism. Every upward adjustment the seller has made to EBITDA is examined. The advisor’s job is to determine whether each add-back meets the standard test: would this cost recur if the business continued under its current ownership structure? If yes, it should not be added back to EBITDA.

Beyond challenging adjustments, a buy-side QoE also identifies items the seller has not surfaced. These findings may include:

• Revenue recognized before it was earned under applicable accounting guidance
• Customer churn or pricing deterioration that compresses the run-rate trajectory
• Deferred maintenance or capital expenditure that is below the level required to sustain current revenue
• Related-party transactions at non-arm’s-length terms that inflate reported margins
• Payroll or benefits costs understated relative to a stand-alone business

Each finding can affect the purchase price, the working capital peg, the escrow requirement, the representation-and-warranty insurance terms, or the proportion of consideration placed in an earnout.

Scope and Engagement Structure

A standard buy-side quality of earnings due diligence engagement covers 2 to 3 years of historical financials plus a trailing twelve months. The advisor typically requests a data room containing trial balances, general ledger detail, bank statements, customer contracts, and the management-prepared EBITDA bridge. Fieldwork includes interviews with the target’s CFO and accounting team. The final report is delivered to the acquirer’s deal team, its lenders, and sometimes the investment committee.

Engagements typically run 4 to 6 weeks, though compressed processes in competitive auctions can shorten that window.

Sell-Side Quality of Earnings: The Seller’s Preparation

A sell-side QoE is commissioned by the company preparing for a transaction, typically 6 to 12 months before going to market, or at least before the first letter of intent. The seller’s advisor reviews the same financial data a buyer’s team would examine, produces a defensible adjusted EBITDA schedule, and delivers a report that can be shared in the data room.

Why Sellers Commission Their Own QoE

Historically, only buyers ordered quality of earnings reports. Sell-side QoE has become standard practice in middle-market transactions because it shifts leverage in the seller’s favor. Specific benefits include:

• Price support. A seller who presents a clean, CPA-prepared adjusted EBITDA figure from a credible firm gives buyers less room to argue the number down. The gap between reported and adjusted EBITDA can be substantial in owner-managed businesses, and a defensible schedule pre-empts the most aggressive buyer challenges.
• Deal acceleration. When a buyer receives a sell-side QoE from a recognized firm, its advisors can often narrow their own confirmatory diligence scope and shorten the timeline, because much of the analytical groundwork is already documented in the data room.
• Fewer surprises. Working through the QoE process before going to market surfaces accounting issues that the seller can correct or explain. A buyer discovering those issues during diligence has more leverage to renegotiate terms or withdraw.
• Competitive process management. In a multi-buyer auction, giving every bidder the same starting point levels the field and prevents individual buyers from using diligence findings to get exclusive price reductions.

What a Sell-Side QoE Does Not Do

A sell-side report represents the seller’s best, professionally supported view of adjusted EBITDA. It does not eliminate the buyer’s own diligence, and sophisticated buyers will conduct at least a confirmatory review even when a sell-side QoE is provided. If a buyer’s advisors find material issues the sell-side report did not surface, the seller’s credibility is damaged and the negotiating dynamic shifts quickly.

Sellers should engage a firm that will challenge the numbers honestly rather than one that simply validates the seller’s management presentation. A report that does not withstand scrutiny creates more problems than it solves.

How Buy-Side and Sell-Side QoE Differ: A Comparison

Dimension	Buy-Side QoE	Sell-Side QoE
Who orders it	Acquirer / private equity	Seller / management
Primary goal	Identify risk and validate price	Support EBITDA, reduce buyer friction
EBITDA bias	Conservative (find downward adjustments)	Supportable (maximize defensible add-backs)
Audience	Buyer’s deal team, lenders, IC	Buyer data room, all prospective buyers
Timing	During exclusivity or auction process	Pre-market, 6-12 months before close
Typical scope	Full review, 2-3 years plus TTM	Full review, same depth
Sharing	Proprietary to buyer	Broadly distributed in data room

EBITDA Add-Backs: Where Perspective Diverges Most

EBITDA add-backs are the single area where buy-side and sell-side views diverge most sharply. The seller’s goal is to identify every legitimate adjustment that increases normalized earnings. The buyer’s goal is to challenge every adjustment that does not meet a conservative standard.

Adjustments That Consistently Hold Up

Legitimate EBITDA add-backs that tend to survive quality of earnings due diligence from both sides include:

• Above-market owner compensation. If a founder is drawing a salary materially above the market rate for the position, the excess is a legitimate add-back, provided a replacement hire at market rate would actually be made.
• Discrete, non-recurring legal costs. A single litigation settlement that has been fully resolved and will not recur is generally defensible.
• Transaction costs. Investment banking fees, legal fees, and advisory costs incurred specifically in connection with the sale are clearly non-recurring.
• One-time system implementations. A one-time ERP rollout that has been completed is typically accepted, though buyers watch carefully for companies that have a new system implementation every other year.

Adjustments That Buyers Reject

The following add-backs are frequently challenged and often disallowed in full or in part:

• Recurring maintenance or repair costs classified as one-time. If the company has replaced major equipment or incurred facilities repairs in multiple years, buyers will treat that as a recurring operating cost.
• Allocated personal expenses. Personal vehicle expenses, travel mixed with personal use, and similar charges run through the business are subject to close scrutiny.
• “Synergy” add-backs for costs the buyer will eliminate. Buyers generally do not give sellers credit for synergies they have not yet achieved.
• Customer or contract losses after the measurement period. If a significant customer has left or a key contract has expired after the trailing twelve months, buyers will discount the revenue run rate even if it appeared in the historical financials.

Working Capital and the Deal Mechanics

Quality of earnings due diligence is closely tied to the working capital analysis. The net working capital peg, the target level of current assets minus current liabilities at closing, is typically derived from a trailing twelve-month average of normalized working capital. Both the buyer’s and seller’s QoE advisors spend significant time on this calculation because a favorable peg can transfer millions of dollars from one party to the other.

The AICPA’s M&A due diligence guidance describes the integration of financial statement analysis and deal structure mechanics as a core competency in transaction advisory services. In practice, working-capital purchase-price adjustment provisions now appear in more than 90 percent of private-target transactions, according to the SRS Acquiom Working Capital Purchase Price Adjustment Study, and disputes over the post-closing true-up are among the most common sources of post-closing claims.

When to Engage Transaction Advisory Support

Whether you are buying or selling, engaging a qualified transaction advisory team early creates optionality. For sellers, commissioning a sell-side QoE 6 to 12 months before going to market gives time to address issues that surface and present a cleaner story to buyers. For buyers, engaging a buy-side team at the letter-of-intent stage or during exclusivity ensures that diligence findings inform final pricing and deal structure before commitments are locked in.

Firms like Modus that combine audit and assurance capabilities with dedicated transaction advisory services can provide QoE teams that understand both the accounting standards underlying the adjustments and the deal mechanics that determine how those adjustments affect price. AI-assisted data analysis speeds the initial transaction population review, which is especially useful in compressed auction timelines where four to six weeks of conventional diligence is not available.

Related reading: Yellow Book (GAGAS) Audits: When Are They Required?

Frequently Asked Questions

What is the difference between buy-side and sell-side quality of earnings?

A buy-side quality of earnings report is commissioned by the acquirer to verify the target’s adjusted EBITDA and identify risks that could affect price or deal structure. A sell-side quality of earnings report is commissioned by the seller to pre-validate the adjusted EBITDA, reduce buyer friction during diligence, and support a stronger negotiating position. Both cover the same financial data, but from opposite perspectives with different goals.

Is a quality of earnings report the same as an audit?

No. A quality of earnings report is a financial due diligence engagement, not an audit. It does not express an opinion under generally accepted auditing standards and does not result in an auditor’s report. A QoE is typically a consulting engagement focused on normalized earnings and deal-relevant financial metrics rather than on whether the financial statements as a whole are fairly presented.

How long does a quality of earnings engagement take?

Most quality of earnings engagements run 4 to 6 weeks from kickoff to a draft report, with additional time for management review and finalization. Compressed auction processes sometimes require faster turnarounds. Sell-side engagements commissioned well before going to market may take longer because management is simultaneously running the business and responding to information requests.

What EBITDA add-backs do buyers typically reject?

Buyers most commonly reject add-backs for expenses that are recurring even if they occur irregularly (maintenance, minor litigation, system costs), personal expenses run through the business that lack clear documentation, and forward-looking synergies the buyer has not yet achieved. The standard test is whether the cost would recur if the company continued operating under its current structure.

How does a sell-side QoE affect deal pricing?

A credible sell-side QoE from a recognized firm tends to support a higher and more defensible adjusted EBITDA figure, which increases the buyer’s confidence in the number and reduces the discount buyers build in for uncertainty. In practice, a well-prepared sell-side QoE reduces the number of diligence surprises that a buyer can use as leverage for price reductions, which helps the seller preserve the value it brings to the table.

Who should commission a quality of earnings report?

Any buyer or seller involved in a middle-market transaction where EBITDA-based valuation drives the price should commission a QoE. Buyers in private equity, corporate development, or family office contexts routinely order buy-side QoE reports for transactions above approximately $5 million in EBITDA or $20 to $30 million in transaction value. Sellers preparing for a competitive process increasingly commission sell-side QoE reports to control the narrative and reduce diligence attrition.