Buyers don’t read financial statements the way owners do. Where you see years of hard work, a buyer sees performance to validate the purchase price.. Knowing what they’ll actually check before you go to market can make the difference between a smooth close and questions that affect the deal late in the process.
Here’s what shows up under the surface of your numbers and how to get ahead of it.
Do Your Last Three to Five Years Add Up?
Most buyers build their models from your last three to five years of performance. A steady upward trend gives them confidence in your projections. They’ll also look closely at your last twelve months. Strong long-term numbers paired with a recent dip will raise questions about what caused it and whether it is temporary.
What buyers check here:
- Revenue and earnings trends across three to five years
- Monthly performance over the trailing twelve months
- Whether any recent decline has a clear, explainable cause
What a Quality of Earnings Review Adjusts
A Quality of Earnings (QofE) assessment is an independent review of the accuracy, composition and sustainability of your earnings. It may also adjust EBITDA to show a normalized view of the company’s performance.
Most owners have some costs that a new owner wouldn’t carry forward. These may include above-market compensation, personal expenses and one-time legal fees. A QofE typically reviews:
- Owner compensation normalized to market rate
- One-time costs such as legal settlements or relocation
- Related-party transactions such as rent paid to an entity you also control
- Discretionary spending run through the business
Depending on the size and complexity of the transaction, commissioning your own QofE before a buyer runs theirs can help you address questions early and support your adjustments. Your M&A advisor can help determine whether one makes sense for your business.
Liabilities That Don’t Show Up on Your Balance Sheet
Due diligence looks past the balance sheet for obligations that may affect the business even though they aren’t a line item. When these surface late, they can influence a buyer’s risk assessment, deal structure or purchase agreement.
Buyers commonly look for:
- Unresolved litigation or regulatory exposure
- Contracts with unfavorable termination or change-of-control clauses
- Underfunded benefit or deferred compensation obligations
- Environmental exposure tied to current or past facilities
None of these automatically end a deal. Identifying them early gives you time to provide context and address buyer concerns directly.
Why Cash Matters as Much as Profit
Financial buyers care about how effectively reported earnings turn into cash. A business can report strong earnings and still struggle to fund debt service if collections are slow or the company requires significant reinvestment.
Buyers check this by comparing EBITDA with actual cash flow over multiple periods. They’ll look for recurring gaps that may point to collection problems, working-capital demands or capital expenditures.
How to Get Ready Before a Buyer Asks
Review your own financials as if you were the buyer before you go to market:
- Build a clean multi-year history.
- Document owner-specific costs and one-time adjustments.
- Inventory off-balance-sheet exposure, including contracts, litigation and benefit obligations.
- Track how earnings convert into cash over time.
Businesses that go through due diligence with the fewest surprises are almost always the ones that ran this exercise themselves first. Need help preparing for a sale? Schedule a free consultation with ArkMalibu.
Frequently Asked Questions
What is a Quality of Earnings assessment?
An independent review of the accuracy, composition and sustainability of your earnings. It can also identify owner-specific costs and one-time items that affect normalized EBITDA.
How many years of financials do buyers review?
Buyers commonly review three to five years of history, plus monthly detail for the trailing twelve months.
What hidden liabilities do buyers look for?
Buyers may examine unresolved litigation, unfavorable contract terms, underfunded benefit plans and environmental exposure.
Should I get a QofE before going to market?
A sell-side QofE can be valuable for larger or more complex transactions. Your M&A advisor can help determine whether the investment makes sense for your business.
ArkMalibu works with owners to prepare their financials and positioning well ahead of due diligence. Schedule a Consultation to learn more.
