Quality of Earnings and the Hidden Risks in Acquisitions

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Quality of Earnings and the Hidden Risks in Acquisitions

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Summary

In this episode of Main Street Deals, Sam Rosati and Kevin Henderson break down the role of Quality of Earnings reports in small business acquisitions and why financial diligence can make or break a deal. They explain how Q of E reports help buyers validate a company’s financial reality, uncover hidden risks, and avoid dramatically overpaying for inflated or inaccurate earnings. The conversation walks through the mechanics of revenue testing, working capital analysis, cash proofs, and normalized EBITDA adjustments while also highlighting the limitations of Q of E reports in SMB transactions. Sam and Kevin also share real-world examples of deals where financial diligence uncovered major issues, forced renegotiations, or protected buyers from catastrophic mistakes. We discuss: What a Quality of Earnings report actually is and how it differs from audited financials Why inaccurate seller financials can dramatically inflate purchase price How cash proofs and revenue testing uncover hidden financial issues The most common EBITDA adjustments that lead to deal renegotiations Why small business buyers should rarely skip financial diligence The limitations of Q of E reports and the fraud risks they cannot fully eliminate How working capital analysis impacts deal structure and purchase price Why third-party diligence providers add psychological and negotiation leverage during acquisitions This episode is a practical guide for SMB buyers, investors, and operators who want to understand the real financial risks hiding inside acquisition deals. Links: SMB Law Group - https://smblaw.group/ Evan on LinkedIn - https://www.linkedin.com/in/evan-thomson-327a78216/ Eric on LinkedIn - https://www.linkedin.com/in/eric-b-pacifici/ Kevin on LinkedIn - https://www.linkedin.com/in/khendersonco/ Sam on LinkedIn - https://www.linkedin.com/in/sam-rosati-68787a8/ Topics: (00:00:00) - Intro(00:01:11) - What is a QOE?(00:04:45) - Assurance vs audit(00:07:20) - Inside the workbook(00:09:25) - Restating the P&L(00:13:39) - Balance sheet working capital(00:15:05) - Cash proof testing(00:19:07) - Limitations and QOE lite(00:23:38) - Fraud risks and lender requirements(00:25:52) - Renegotiating after findings(00:37:28) - Who can skip QOE(00:40:30) - When QOE is better(00:42:41) - Wrap up and reviews

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