In almost every lower middle market transaction, the buyer will commission a quality of earnings analysis — a detailed financial examination that goes far beyond a standard audit. It scrutinizes revenue recognition, expense classification, customer concentration, working capital trends, and the sustainability of reported earnings. The findings often become the basis for final pricing adjustments.
Most founders encounter a quality of earnings report as a reactive experience: a buyer's accounting firm arrives, requests months of detailed data, and produces findings that frequently result in downward adjustments to the purchase price. This dynamic puts the seller on the defensive and shifts negotiating leverage to the buyer.
There is a better approach. Founders who proactively build a quality of earnings narrative before going to market gain a significant advantage. By conducting their own analysis — or working with an advisor to do so — they identify and address potential issues before a buyer discovers them, and they control how adjustments are presented.
The first step is understanding what a quality of earnings analysis actually examines. At its core, the analysis seeks to determine the true, sustainable, recurring earnings of the business — stripped of one-time items, owner-specific expenses, and accounting decisions that may distort the picture. The result is an adjusted EBITDA figure that represents the economic reality a buyer is acquiring.
Common adjustments include removing above-market owner compensation, personal expenses run through the business, one-time legal or consulting fees, and non-recurring revenue or expenses. Each of these adjustments tells a story about the business, and how they are presented matters enormously. A well-documented adjustment with clear supporting evidence strengthens the narrative. A poorly supported one invites skepticism.
Revenue quality is an area that receives intense scrutiny. Buyers want to understand not just how much revenue the business generates, but how durable it is. They will examine customer concentration, contract terms, renewal rates, and the pipeline of future revenue. Founders who can present this analysis proactively — with clear data and honest context — build credibility that pays dividends throughout the process.
Working capital is another area where proactive analysis prevents surprises. Buyers typically expect a normal level of working capital to be delivered at close, and disagreements over what constitutes normal working capital can create significant friction. Understanding your own working capital patterns and presenting them clearly reduces the risk of last-minute disputes.
The goal of a sell-side quality of earnings narrative is not to make the business look better than it is. It is to present the business accurately, transparently, and in the best possible light — supported by clean data and thoughtful context. Buyers respect this approach because it reduces their due diligence risk and accelerates the process.
Founders who invest in this preparation typically find that buy-side quality of earnings reports produce fewer surprises, smaller adjustments, and smoother negotiations. The time and cost of the preparation are almost always justified by the value they protect.