QUALITY OF EARNINGS - IS IT ACTUALLY NECESSARY?
Searchfund fam,
I am under LOI on a $10mm purchase price deal. I have four months to complete diligence.
I know "best practice" in the search fund community is to complete a QofE. That said, all advisors that I'm working with on my search (my lawyer, buyside banker, etc.) have suggested that a QofE would be a waste of money for this deal.
I do not want to re-trade this deal - so I see no value in the QofE for those purposes. That said, a QofE would give me a lot of comfort in closing the transaction and stepping into operate the business. The company is a small manufacturing operation ($10.5mm in sales; $2mm in EBITDA). The company has used a very small CPA firm throughout it's history, and the financial records are not pristine - so there would be some comfort in getting the numbers checked. I believe the owner is an honorable man, and I do not believe there are any skeletons in the closet intentionally being hidden.
So my question: what are the real benefits to getting a QofE done at this point in time? Thank you for any guidance and perspective
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