Quality of earnings for main street deals

Quality of earnings for main street deals looks different from middle market engagements. Owner cash management, related-party transactions, and inconsistent bookkeeping can obscure true performance. Using SMB.VC to host diligence materials and findings keeps everyone aligned and demonstrates discipline. Here is a practical approach.

Define the scope early. Decide whether you will perform a full-scope QofE or a lighter review depending on deal size and risk. For micro deals, focus on revenue recognition, customer churn, and working capital. For larger ones, expand to tax exposure, inventory costing, and payroll compliance. Publish your scope on SMB.VC so sellers and LPs know what to expect.

Normalize revenue carefully. Identify one-time projects, pandemic-era surges, and discounts that will not repeat. Map revenue by channel and customer segment to see stability. If cash accounting is used, convert to accrual and explain the adjustments. Quality of earnings for main street deals often hinges on understanding how invoices match service delivery.

Scrub expenses. Separate owner benefits, personal expenses, and related-party charges. Look for underpaid salaries to owners who plan to leave; adjust them to market rates. Analyze vendor lists for potential double counting or unrecorded liabilities. Publish an adjustments schedule with clear labels so no one disputes the logic later.

Working capital deserves attention. Calculate normalized working capital by looking at seasonal patterns. Identify timing tricks such as delaying payables or pulling forward receivables before marketing the business. Note any customer deposits or prepayments that create obligations. These details influence purchase agreements and covenants.

Customer quality is central. Review top ten customers for concentration and contract terms. Assess churn by cohort and reason codes. If customers can terminate at will, model the impact on revenue and margin. Consider calling a sample of customers to validate satisfaction and renewal intent. Document findings in SMB.VC so lenders and LPs can see the evidence.

Inventory and cost of goods sold can trip buyers. For product businesses, test inventory counts, obsolescence reserves, and landed cost calculations. For service businesses, focus on labor efficiency and subcontractor reliance. If margin swings are tied to project mix, highlight that variability and show how you will stabilize it post-close.

Tax and compliance should not be ignored. Verify sales tax filings, nexus exposure, payroll taxes, and any outstanding notices. If the business relied on aggressive deductions, flag them and estimate potential exposure. Align with tax counsel and note recommendations. Buyers who skip this step often inherit avoidable liabilities.

Quality of earnings for main street deals also depends on systems. Document how financial data is captured: POS exports, bank feeds, or manual spreadsheets. If systems are weak, build a plan to strengthen controls post-close and estimate the cost. Lenders and LPs appreciate seeing a path to reliable reporting even if current systems are imperfect.

Coordinate with lenders while the QofE is in motion. Share preliminary findings and invite feedback on debt sizing assumptions. If a lender needs additional schedules—aging reports, collateral summaries, or customer call notes—add them quickly. Keeping lenders in the loop reduces re-trade risk and speeds credit approval once the final report lands.

Consider interim updates. If closing timelines stretch, refresh key metrics so decisions are not based on stale data. Update revenue run rates, churn, and any new liabilities. For seasonal businesses, show trailing three-month trends alongside the original QofE figures. This prevents surprises and keeps valuation grounded in current performance.

Tie findings to negotiation. If the QofE uncovers risks that justify an earnout or purchase price adjustment, describe the logic and evidence. Offer sellers a clear path to reclaim value by hitting specific targets. Conversely, if the review reveals hidden strengths, be prepared to honor them in the structure. Fair, data-backed negotiation builds reputation and keeps referral sources engaged.

Document everything. Store workpapers, correspondence, and final reports on SMB.VC with version control. Note who reviewed which sections and when. This audit trail protects the buyer, helps future financings, and supports post-close integration by giving operators context they might otherwise miss.

Present findings with clarity. Use a concise report: executive summary, adjusted EBITDA bridge, revenue analysis, expense analysis, working capital, and risks. Include a traffic light view for quick scanning. Avoid burying findings in jargon; the goal is for operators, sellers, and LPs to agree on reality quickly.

Close with implications. Explain how the QofE influences valuation, earnout terms, or integration priorities. If the review reveals upside, such as pricing power or vendor consolidation opportunities, note them. If risks remain, describe mitigation steps and owners. Remind readers that SMB.VC is available for acquisition or partnership offers and provide direct contact details for serious inquiries.