Hi,

I would be interested to hear the reasoning for why financial due diligence would be a waste in your case. In my experience, FDD would include a "Quality of Earnings Analysis" to understand normalized earnings, but also analyses to understand normalized working capital and debt-like items. In a small business, I would want to independently confirm the amount of normalized cash flow the business has generated historically (free of one-time benefits and inclusive of any necessary expenses that may be hidden (or excluded) in the historical periods). I also would not want to assume liabilities I was not aware of. Although I haven't bought a company for myself yet, my colleagues who have closed on their own acquisitions as independent sponsors or searchers have simply scaled down the tier of FDD providers they used so it covered the bases but fit their budgets; I am not aware of any that skipped it entirely. It is a small sample size though. I've never seen a deal as a buyer in private equity or corporate M&A where there wasn't at least a bare minimum of FDD.

Jake

It's like insurance, you're only glad you had it in the downside scenario. Did you check his tax returns? Also, why are you anonymous... it's hard to build community anonymously... GL.

Maybe you could pay for a light review, instead of a full fledged QOE...

I'd think this would be most necessary when there's a "hockey stick" pattern in revenue or ebitda in the target. Also, there are some cases when earnings are overstated. This should be less concerning if the target accounts on a modified cash basis. But if it's accrual, then the company could present 3 year old receivables as part of the sale knowing that they should have been written off. I considered buying a company with large amounts of inventory only to find out that it was 11 years overdue for an inventory write down which would have eliminated years of taxable income. And I figured that if the owner would misrepresent finances to the IRS and his lenders, he'd have no problem doing so to me. I'd think that a persistent MBA with time and an understanding of accounting could do QoE themselves I think it's necessary.

Hi - financial DD is obviously important, and would not recommend just taking the seller's word. That's an easy way to get burned. However, there might be more cost effective ways to complete a light QOE. Do you have the skillset to prioritise key risk areas in the financials? You may find that you can do 80% yourself. Even if you are not planning on re-trading the deal, you might find that the QOE helps clarify any potential issues around working capital with the seller before you close. One final perspective would be to consider the QOE as a piece of insurance on your deal.

I am happy to discuss benefits of QofE. At a very high level it will help you get comfort the earnings are accurate and reliable. I don't typically recommend "light" diligence as I typically want to be in the details as that is where I often find the real issues. Happy to connect if you are interested.

I agree with your advisors and would punt the QofE. QofE's are typically done as a matter of habit because they're often required by lenders or investors, but why do it if not required? QofE's aren't audits, and you're not getting additional assurance, You can tailor your financial diligence to the target company and get what you need without the additional cost of the QoE.

In my teachings, I suggest following in sequence when buying a business by a first-time buyer 1) get comfortable with the demand side of the business, 2) your ability to manage it and your comfort in doing so, and 3) then QofE[redacted]Few pointers a) Look at multiple years of earnings. b) Typical DD gives you one year of QofE by looking at 3 years of financials, c) analyze at least 5 years of financials(Lately I at least look at 1o years of sales, not necessarily profits) , d) QofE by itself is not enough. Cash flow is. Analyze why earnings are not going to shareholder? e) A business with high assets could be easy to buy and may make one feel more secure, but those are difficult to grow (generally stay away from those; don't waste time), f) Do Delta analysis of earnings, g) Small business owners typically under-report inventory, not over-report (one answer mentions 11 years of inventory. I doubt if tax returns show that. Also, QuickBooks has a format that shows cumulative purchases as inventory. I have often been misled by that). I can go on for hours, but would stop here.

Assuming that you are doing FDD (which you should always do for obvious reasons) and this is just a question re a QOE analysis, then I think the fact that you are asking this question tells you that you should do one - however basic. Your advisers are not the ones parting with $10mm and you will kick yourself later down the line if there are skeletons in the closet. If the financial records are not pristine and you are not comfortable - then do what you need to do to close the deal with confidence. You only get to do this once and 4 months is plenty of time. As other posts have suggested - can you do a light QOE analysis yourself? Maybe give it a go and then get a connection/friend to sanity check your findings. Indeed, it may be a useful exercise for you to really dig down into the financials if you are the stepping in to operate the business as well.

Understood that you aren't looking to re-trade but that is not the real value of QofE. The real value is to give yourself and investors confidence that the historical/adjusted numbers you are basing the valuation on due in fact hold together when "pros" dig into the financials. We do tailor our due diligence / QofE procedures to each deal and would be happy to discuss a targeted scope that brings you the value you need at the right stage of the transaction. If you would like to discuss any of this directly I can be reached at [redacted]

To add to the above, 95% of transactions we represent require a QofE. You can contact various firms who will cater to the size of the deal. For smaller deals I have seen certain firms be as low as $25K for the service where they focus on certain areas.

You'll usually (not always) get a ROI on the QoE. Seller's EBITDA is rarely 100% accurate and seller's adjustments are often inaccurately calculated. Sellers will almost always be a little biased. Simple calculation: $20K QoE, 4x EBITDA multiple, downward diligence adjustment (EBITDA) of $10,000. In this scenario you may have just spent $20K to save $40K on price or other consideration. There's almost always a diligence adjustment and many times they are much larger than $10K. Also, the working capital peg is extremely important when the Target has substantial working capital needs. If you miss on the peg, it will cost you in the true-up... You can tailor the financial diligence to suit your needs - doesn't have to be a "full QoE". Be careful!

Assuming a traditional SF-model, from an investor perspective, you might want to consider their needs. The rapport you build with the seller is invaluable, but might be overlooked by investors. As such, the QofE will likely support your investors to get comfortable with the deal too.

QofE is a must, no ifs, no buts. There are thousand ways to calculate profits even if the owner is honest. The problem is that the owners do not know accounting, And, sometimes their accountant do not know it or are constrained by the fees they get paid. In all mu deals, I go beyond adj. EBITDA to making adjustments for accounting methods. Also, the DFCF balance sheet is not as simple as the name implies. I have seen many buyers suffer big times for not understanding this. .Feel free to contact.