The seller says the business does $800K in EBITDA. The broker confirms it. The listing looks clean.
Then you hire a QofE firm. Three weeks later, you find out $180K of that “EBITDA” is a one-time PPP loan forgiveness, the owner runs two personal vehicles through the business, and revenue is concentrated in a single client who just signed a competitor.
Real EBITDA: $540K. Real multiple: 4.7x instead of 3.4x. Deal is dead or repriced.
That is what a quality of earnings report does. It tells you what the business actually earns before you wire money.
What a Quality of Earnings Report Actually Is
A quality of earnings report is a financial due diligence analysis performed by an independent accounting firm. It examines the target company’s historical financials, typically the last 2 to 3 years, and determines whether the reported earnings are accurate, sustainable, and repeatable.
It is not a full audit. An audit verifies that financial statements comply with accounting standards. A QofE goes in a different direction entirely: it tells a buyer whether the cash flow they are paying a multiple on is real.
The analysis breaks down every major revenue and expense line item. It identifies add-backs that are legitimate and flags ones that are not. It examines working capital trends, revenue concentration, customer churn, and any one-time items that inflated or deflated the numbers in a given year. The output is a written report with adjusted EBITDA or SDE figures that reflect economic reality, not the seller’s best-case presentation.
Why Every SBA Deal Needs One
SBA lenders require a quality of earnings analysis on most deals above $250K in acquisition price. Some lenders set the threshold at $500K. Either way, if you are financing an acquisition with an SBA 7(a) loan, you will need a QofE before the loan closes.
And this is not bureaucratic box-checking. The lender needs to know their DSCR calculation is based on real numbers. We target a 2x DSCR and will not move forward on a deal below 1.5x even with synergies. If the seller’s stated SDE is inflated, that ratio collapses.
Here is what that looks like in practice. Say a seller claims $350K in SDE on a $1.05M acquisition price (a 3.0x multiple). At 10% equity injection, your SBA loan is $945K over 10 years. Monthly debt service is roughly $10,500. You need at least $21,000 per month in post-debt cash flow to hit 2x DSCR. That is $252K per year.
If the QofE brings true SDE down to $260K, your DSCR drops to 1.24x. The deal either gets repriced or dies. Knowing that before you close is the entire point.
What the QofE Firm Actually Examines
Not all quality of earnings reports are created equal. A good one goes deep on all of the following areas, and the firm should be walking you through each one in their deliverable.
Revenue quality. Are revenues recurring or one-time? Is there customer concentration risk? A business where 40% of revenue comes from a single client is a materially different risk profile than one with 200 customers, each under 5%. We have seen deals that looked like $900K SDE businesses on paper turn into $600K businesses once you stripped out a single contract that was not going to renew.
Add-back legitimacy. Sellers and their brokers add back everything they can. Owner compensation above market replacement cost. Personal vehicle expenses. Family members on payroll who do not actually work there. Some of these add-backs are real. Some are not. A QofE firm validates which add-backs a lender will actually accept (and which ones are, frankly, fiction).
Expense normalization. Did the seller defer maintenance in year three to juice the numbers before listing? Are there understated expenses that will hit you post-acquisition? QofE analysts look at expense trends across the full review period.
Working capital analysis. What is the normalized working capital requirement for the business? This matters for SBA deals because working capital is sometimes built into the loan structure. An accurate baseline prevents surprises on day one.
Non-recurring items. PPP loans, insurance settlements, asset sales, one-time contracts. These inflate EBITDA in the year they appear. The QofE separates recurring earnings from noise.
Revenue recognition policies. How does the business book revenue? Cash or accrual? Are there deferred revenue liabilities that get transferred to the buyer?
How Much It Costs and Who Pays
For a business in the $500K to $3M acquisition price range, a quality of earnings report typically costs $5,000 to $15,000 depending on the complexity of the financials and the firm doing the work.
The buyer pays. It is a buyer-side diligence expense. Sellers occasionally push back on this or offer a sell-side QofE prepared before listing, but buyer-side QofEs are the standard for SBA transactions.
The cost is built into your closing cost budget. On a $1.5M SBA deal, total closing costs including QofE, legal, lender fees, and appraisals typically run $25,000 to $40,000. The QofE is one line item in that total.
If a seller refuses to provide the financial access needed for a QofE, that is a hard stop. No reputable lender will close an SBA acquisition without one. Any seller who resists that process is telling you something about the books.
CPA-Reviewed Financials Are Not a Substitute
A lot of first-time buyers see that a seller has CPA-compiled or CPA-reviewed financials and assume the numbers are verified.
They are not.
CPA-compiled financials means the accountant organized the information the seller provided. They are not certifying accuracy. CPA-reviewed financials are one step above that, but still not an audit, and definitely not a QofE.
Tax returns are often cited as the gold standard for “real” numbers because sellers cannot lie to the IRS. Tax returns are useful, but they are not sufficient on their own for SBA underwriting or for a buyer who needs to understand true cash flow. SBA.gov outlines the documentation requirements for 7(a) lending, and a QofE or equivalent financial analysis is part of the standard underwriting package for good reason.
A QofE involves independent verification, document requests, management interviews, and analysis that no CPA compilation provides. Different product. Different purpose.
When to Order the QofE in Your Deal Timeline
Order it first. Before legal. Before lender underwriting goes deep. Before you spend $15,000 on an attorney drafting an APA.
The typical SBA acquisition timeline looks like this:
- Offer and negotiation.
- Signed LOI with exclusivity period (usually 45 to 90 days).
- QofE ordered within the first week of exclusivity.
- QofE delivered within 3 to 4 weeks.
- Lender underwriting runs concurrently with or immediately after QofE.
- Legal diligence and APA negotiation.
- SBA commitment letter.
- Close.
Ordering the QofE late is one of the most common mistakes buyers make. If you wait until week six of a 60-day exclusivity window and the QofE reveals material issues, you are out of time. You have already spent money on legal fees. The seller knows you are under pressure.
So order it early. Let the numbers tell you whether to keep going.
So the QofE Found Problems. Now What?
Finding issues in a QofE is not unusual. In fact, from what we have seen across hundreds of deals, it is more or less the norm. The question is whether the issues are deal-killers or price resets.
If the QofE reduces SDE by 10% to 15% and you can reprice accordingly, the deal often still works. You go back to the seller with a revised offer backed by independent analysis. Some sellers accept. Some do not. That is their choice.
But if the QofE reveals fraudulent misrepresentation, material concentration risk you did not know about, or cash flow that cannot clear SBA underwriting at any reasonable price, you walk.
The $8,000 you spent on the QofE is not a loss. It is insurance against writing a $120,000 equity injection check into a business that cannot support the debt.
We review 120 to 150 deals per week at Regalis. The ones that survive that process are the ones where the quality of earnings report holds up.
Frequently Asked Questions
What is a quality of earnings report used for in a business acquisition?
A quality of earnings report verifies that a target company’s reported cash flow is accurate, sustainable, and repeatable. It identifies inflated add-backs, one-time revenue items, and expense irregularities before closing. For SBA-financed acquisitions, it is a standard lender requirement and forms the basis for DSCR calculations during underwriting.
How long does a quality of earnings report take?
Most QofE reports for small business acquisitions take 2 to 4 weeks from the time the buyer’s firm receives full access to financials. Timelines vary based on how organized the seller’s books are and the complexity of the business. Complex multi-entity structures or messy books can push that to 5 to 6 weeks.
Is a quality of earnings report the same as an audit?
No. An audit verifies that financial statements comply with accounting standards. A quality of earnings report focuses specifically on whether earnings are sustainable and accurately represented for acquisition purposes. QofE reports involve independent analysis, document verification, and management interviews that go well beyond a standard CPA compilation, but they are a different product than an audit.
What is a reasonable QofE finding that does not kill a deal?
An add-back that gets partially disallowed, a modest revenue adjustment for a one-time contract, or a working capital baseline that differs from the seller’s assumption. These are normal findings that rarely kill deals and may support a price reduction request. What kills deals is systematic misrepresentation, customer concentration above 40% to 50% in a single client, or adjusted SDE that drops below the point where the deal can clear a 1.5x DSCR floor at any workable price (and our target is 2x, not 1.5x).
Can the seller provide the QofE instead of the buyer ordering one?
Sellers can commission a sell-side QofE before listing to make their business more credible to buyers, and this can speed up the process. However, most SBA lenders want a buyer-side QofE commissioned by an independent firm with no relationship to the seller. A sell-side QofE can be a useful starting point but rarely replaces the buyer-side analysis entirely.
Looking at a Deal and Want to Know If the Numbers Hold Up?
Regalis Capital provides buy-side M&A advisory for acquisitions primarily financed through SBA 7(a) lending. We run financial analysis, coordinate QofE firms, manage lender relationships, and keep deals from falling apart over exactly the issues covered in this article.
If you are in diligence on a deal or evaluating whether an acquisition makes sense, start here.