Why “Quality of Earnings” Is a Deal-Maker (or Breaker) inTech M&A

Receiving a Letter of Intent (LOI) from a buyer can feel like crossing the finish line - but in reality, it’s just the beginning of acritical and often intense phase: the Quality of Earnings (QoE) analysis.

This is where the buyer puts your business under the microscope. Their goal? To validate that the earnings shown on your P&L arethe result of real, core operations, not accounting quirks or temporary inflows.

What Buyers Are Looking For

Buyers want clarity and reliability. Specifically, they’relooking to:

• Understand your revenue composition - including licenses, subscriptions, maintenance, services, and even government grants
• Assess how revenue is recognized (upfront, ratably, milestone-based)
• Ensure financials are reported on an accrual basis, which offers a clearer and more consistent view of the business than cash-based accounting

If you’re still on a cash basis, consider transitioning before starting an M&A process. Most buyers strongly prefer accrual, and shifting too late can introduce friction and raise questions.

A Common Trap: Grants as Revenue

We often see tech companies, especially in Europe, book R&D grants or government subsidies as revenue. While these inflows might be material for cash flow, they are not typically viewed by buyers as core orrecurring revenue.

Buyers tend to discount or entirely remove these items from revenue and EBITDA calculations. And once there's a mismatch between how the seller presents earnings and how the buyer adjusts them, it often leads to valuation reductions - some times significant ones.

The Impact on Valuation

Buyers apply higher multiples to recurring, contracted, and product-driven revenue. Conversely, they discount one-off services,non-operating income, and any irregular sources of cash that can’t be relied on post-acquisition.

A well-prepared QoE package that clearly differentiates recurring from non-recurring revenue, with clean accrual-based accounting, can:

• Speed up diligence
• Build buyer confidence
• Justify a stronger valuation

Final Thoughts

In tech M&A, how you earn matters just as much as how much you earn. Taking the time to clean up your financials and present them theway buyers expect can make all the difference between a smooth deal and a painful renegotiation.

If you're preparing for a transaction or just want to assess how buyers will view your earnings quality, let’s talk.

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