According to Axial's 2025 Dead Deal Report, EBITDA discrepancies discovered during diligence caused 21.3% of broken letters of intent last year — up from 10.6% in 2023. Add non-QoE financial diligence findings and nearly half of all failed deals trace back to financial surprises the buyer didn't see coming.
One document keeps most of those surprises from landing: the quality of earnings report.
If you're buying a business through a search fund or any ETA structure, you will encounter this term. You need to understand what it does, what it costs, and when it changes the deal — before you sign an LOI, not after.
What a QoE report is (and what it isn't)
A quality of earnings report is a financial due diligence document prepared by a third-party accounting firm. It analyzes the target company's financial statements and determines whether reported earnings reflect the actual ongoing economic performance of the business.
It is not an audit. An audit verifies that financial statements conform to GAAP. A QoE looks at whether the earnings number a seller puts on the table — the EBITDA they used to set a price — represents what a buyer will actually earn after close.
That distinction matters. A business can produce audited financial statements that are technically compliant and still present an earnings picture that overstates true cash flow by 20, 30, or 40 percent. The QoE is the tool designed to catch that gap.
What it examines
A standard QoE covers five core areas.
Revenue quality. The analyst looks at whether revenue is recurring, one-time, or inflated. A contract that expires in six months looks the same in financial statements as a multi-year subscription. The QoE distinguishes them. Customer concentration gets scrutinized here too — if 40% of revenue flows from one customer, that's a concentration risk that may not appear anywhere in the seller's package.
EBITDA adjustments and add-backs. This is where most deal disputes originate. Sellers add back expenses they claim are non-recurring — the owner's personal car lease, a one-time legal settlement, a cousin who was on payroll. Some add-backs are legitimate. Others are aggressive or unsupportable. The QoE analyst evaluates each one and determines which to keep, which to reduce, and which to eliminate entirely.
Working capital analysis. What level of net working capital is required to run the business? The seller's representation and the actual operational requirement are often different. This feeds directly into the working capital peg in your purchase agreement — a number that affects how much cash you need at close.
Normalization of owner compensation. Closely held businesses routinely pay owners below or above market rate. A seller running a $3M EBITDA business and taking $500,000 in compensation when a market-rate manager costs $200,000 has a different business than the financials suggest. The QoE re-prices that number.
One-time items and trend analysis. The QoE isolates items that happened once and won't repeat — an insurance settlement, a PPP loan forgiveness, an unusual inventory write-down. Then it looks at three to five years of revenue and margin trends to identify whether the business is growing, stable, or quietly declining.
When you need one
The answer is almost always yes, but the threshold varies.
For deals above $1 million in purchase price, most experienced search fund investors and SBA lenders expect a QoE. The SBA's Standard Operating Procedure (SOP 50 10 8) requires an independent business valuation when goodwill exceeds $250,000 — and most SBA 7(a) acquisition loans trigger that threshold. Many lenders use QoE findings to validate or challenge the valuation that underpins their underwriting.
Practically speaking: if you're doing an ETA deal of any meaningful size and skipping the QoE to save money, you're making a bet with your equity. The average QoE for an SMB acquisition costs between $5,000 and $20,000. The average price adjustment when QoE finds something material is measured in multiples of that — often $100,000 to $500,000 or more depending on deal size.
The math favors the QoE.
You can consider skipping it only in the narrowest circumstances: the business has three to five years of clean, independently reviewed financials; revenue is highly recurring; customer concentration is low; and you have direct operating experience in the industry that gives you pattern recognition a generalist analyst would lack. Even then, most experienced searchers run it anyway.
What the process looks like
The typical QoE engagement runs four to six weeks and requires full access to the target's financial records.
The firm starts by requesting a document package: three to five years of tax returns, internally prepared financials, bank statements, accounts receivable and payable aging reports, payroll records, and key contracts. What they receive versus what they requested tells you something on its own.
From there, analysts build a normalized earnings bridge — a month-by-month or quarter-by-quarter view that strips out noise and identifies the true run-rate EBITDA. They look for revenue that accelerated unusually in the trailing twelve months (timing manipulation is common when sellers know a sale is imminent), expenses that were deferred, and compensation arrangements that don't survive ownership transition.
Findings are presented as a written report with a revised EBITDA figure and a detailed schedule of adjustments. That number becomes the baseline for renegotiation if the gap from seller representations is material.
How findings change the deal
Three outcomes are common.
First, the QoE confirms the seller's claims with minor adjustments. The deal proceeds on essentially the original terms, and you close with confidence in the numbers.
Second, the QoE identifies adjustments that are material but not deal-breaking — typically a revised EBITDA that changes the purchase price meaningfully at the agreed multiple. You go back to the seller with a revised offer. Most sellers who have built a legitimate business will negotiate. Some won't. Either answer is useful information before you've wired funds.
Third, the QoE finds something that kills the deal entirely. Revenue concentration is higher than disclosed. Key customer contracts don't transfer with ownership. The trailing EBITDA is a number that required the owner's full-time involvement and can't be maintained without them. You walk away. The QoE cost is a rounding error compared to what you avoided.
Per Axial's data, financial diligence findings account for a combined 46.6% of broken LOIs across the market. That rate is rising, not falling. Sellers entering the market today know more about how to present financials than they did five years ago. Buyers need to know more about how to verify them.
Who performs them
For SMB acquisitions under $10 million in EBITDA, the QoE is typically performed by one of three types of firms.
Boutique QoE shops that specialize in lower-middle-market transactions — firms like ClearView QoE, Bedrock QoE, and Midwest CPA — built their practices around this deal size. They move faster than Big 4 firms and their pricing is calibrated for deals where $20 million is the top of the range, not the floor.
Regional accounting firms with transaction advisory practices. Quality varies significantly. Ask how many SMB acquisition QoEs they've completed, not how large the firm is.
Generalist CPA firms with due diligence experience. The lowest cost option and often the highest risk. If the analyst hasn't seen multiple acquisition clients in your target industry, their benchmark comparisons are limited.
Budget $8,000 to $15,000 for a solid firm on a $2M to $5M EBITDA deal. Expect the lower end of that range to buy you something functional but not comprehensive. The comprehensive version is worth the difference.
The searcher's discipline
EOD cleared one wire at a time. You don't assume the package is clean because the seller says it is, and you don't proceed until the verification is complete.
The QoE is that verification. It's not a sign of distrust toward the seller. It's the professional standard for any transaction of this size. Sellers who've built legitimate businesses understand that. The ones who resist it — who claim the financials are straightforward and there's no need for the expense — are telling you something with that resistance.
Run the QoE. Read the findings. Use what you learn.
If the numbers hold up, you close with confidence. If they don't, you close with your equity intact. That's the only acceptable outcome on a deal this size. For a deeper look at the full diligence process, see our guide on search fund due diligence: what most buyers miss.
Patriot Growth Capital evaluates acquisition targets through a structured diligence process that includes financial statement review, operator interviews, and independent earnings verification. We are a private equity firm, not a financial advisor. This article is educational and does not constitute investment or acquisition advice.
