M&A Advisory Series: Quality of Earnings Webinar

Housekeeping Items

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Presenters

• Dinkley Ombo: Former auditor, current Chief Relationship Builder. Experience with private, public, nonprofit sectors.
• John Dunnigan: Partner in CFO advisory service practice, 30+ years in financial operations and consulting with public and private companies.

Market Overview

• There's strength in current markets for M&A activity, especially from 2017-2018.
• 2018: Deal sizes remain high, valuations in client base are elevated.
• Transition insights from GAAP financial statements to quality of earnings.

Importance of Quality of Earnings

• Primary Drivers: Many transactions driven by multiples of EBITDA.
• Purpose: Helps buyers understand normalized EBITDA and historical company performance.

Key Focus Areas

• Management Derivative: Buyer dictates focus areas.
• Non-Audit Nature: No minimum standards required, can focus on specific areas per buyer’s interest.
• P&L Focused: Concentrates on understanding historical and core earnings, not issuing an independent opinion.
• Working Capital: Important for assessing future operational cash needs.

Normalizing EBITDA

• Adjustments: Correct errors for GAAP, one-time expenses, unusual items.
  • May include legal expenses, sales of assets, above/below market salaries, non-recurring operational costs.

Detailed Analysis in Quality of Earnings

• Revenue Trends: Examining customer/product/geographic concentration, seasonality.
• Cost of Revenue: Fully loaded cost analysis, consistency of gross margin.
• Operating Expenses: Proper matching of costs and revenues.

Reporting and Steps

• Monthly/Quarterly Basis: Provides detailed breakdown, unlike annual audits.
• Preparation Steps for Sellers: Account reconciliations, better understanding of business operations, proactive identification of issues.

Sell-Side Due Diligence

• Seller’s Perspective: Conducting a quality of earnings can pre-empt buyer’s concerns and provide transparency.
• Adjustment Expectations: Buyers may negotiate purchase price, use escrows, or earn-outs based on findings.

Conclusion

• Key Takeaways: Quality of earnings reports are crucial for both buy-side and sell-side in M&A transactions for better understanding of operational details and financial health.
• Next Webinar: Focus on completeness of tax accruals in M&A process.

Questions and Follow-Up

• Due to time constraints, answers to questions will be followed up individually.
• Encouraged to tune in for the next session.