June 24, 2024

Evaluating the True Value: Critical Role of Sell Side Quality of Earnings Reports for Transactions

By Michael Sacco, Partner, National Leader - Consumer & Industrial Products

Evaluating the True Value: Critical Role of Sell Side Quality of Earnings Reports for Transactions Consumer & Industrial Products

For business owners of consumer product companies, deciding to sell their company or seek investment is a pivotal moment. The stakes are high, and financial outcomes hang in the balance. While traditional financial statements (such as audits or reviews) provide a snapshot of historical performance, they often fall short of revealing critical risks and nuances that potential buyers or investors need to know. Enter the sell-side Quality of Earnings (QofE) report—an essential tool that not only informs buyers but also safeguards value, streamlines transactions, and minimizes surprises.

This article will explore the importance of a sell-side QofE analysis and why it should be a top priority for business owners looking to sell.

What Is a Sell-Side Quality of Earnings Report?

A sell-side Quality of Earnings Report provides an independent and objective assessment of a company’s earnings. It is a critical tool during the due diligence phase of a sale transaction. Here’s why it matters:

Credibility and Preparedness

A sell-side QofE signals to potential buyers that the seller has credible financials and is well-prepared for a sale. These qualities support a clean and smoother transaction process.

Thorough Financial Review

Working with an external team, the seller thoroughly reviews financial numbers and incorporates necessary adjustments. This process paints a clear picture of the company’s financials, especially its profitability.

Accurate Representation

The report confirms that the reported earnings are representative of the company’s actual income. It ensures that the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and add-back amounts are accurate and traceable to source financial information.

Who is your Transaction Advisory Team?

When you go the proactive route and decide to engage for a QofE report before selling your business, you will need to bring in several key members of your broader business team to help anticipate which details to include and uncover the history necessary to make the report accurate and meaningful for potential buyers. That includes:

The business owners or CEO

As the business owner or CEO, you have valuable insight and information about the company’s history, operations, financials, and growth potential.

An M&A advisor or investment banker

An M&A advisor or investment banker can help guide the QofE process, identify potential buyers, and negotiate the sale of the business.

An accountant or financial analyst

An accountant or financial analyst can perform the QofE analysis, provide comments on the company’s financial statements, and identify any adjustments or add-backs to the financials (generally EBITDA) that may be necessary to reflect the company’s true earning power more accurately.

An M&A lawyer

A lawyer can help review and manage any legal or regulatory compliance issues that need to be addressed before the sale.

A tax specialist

A tax specialist, either an accountant, a lawyer, or both, can help structure the deal tax-efficiently and model your after-tax proceeds, that is, what cash you will walk away with.

A management consultant or industry expert

A management consultant or industry expert can help to provide industry insights and identify areas of the business that are performing well and have the potential for growth, which can increase the perceived value of the business to potential buyers.

Depending on the size and complexity of the business, additional team members such as an IT consultant, HR consultant, and other specialized experts may be added to the team. Additionally, the team members may vary depending on the stage of the process and the business’s specific needs.

Industry challenges while contemplating a sale

Several industry challenges often affect the value of a consumer product company. So many variables come into play as a company looks at its own financial position, projections, and valuation, such as:

Supply Chain Disruptions and Volatility

The industry grapples with supply disruptions caused by shifting demand, material price volatility, and geopolitical factors. Once considered resilient, the sprawling global supply chains have faced disruptions and varying freight costs due to demand shifts. Supply chain disruptions have driven material and freight costs higher. Rising competition and regulatory changes further strain margins. Consumer product companies must carefully manage costs while maintaining product quality and meeting demand.

Adaptation to Inflation

Inflationary pressures squeeze consumer product companies between rising supply chain costs and consumer confidence declines. To protect margins, brands and retailers need multifaceted approaches, including pricing adjustments, merchandising strategies, and supply chain optimization.

Shifting Consumer Behaviors and Demands

Empowered consumers demand personalized digital experiences. The acceleration of online shopping and tailored delivery methods continues beyond the pandemic.

Latest Technology

Technology plays a pivotal role in shaping success in today’s rapidly evolving business landscape. Middle-market consumer product companies, despite their size, must recognize the significance of adapting to new technology. Well-operated companies are all looking at technology enhancements that enable faster decision-making, streamlined processes, and quicker responses to market shifts. Also, supply chain optimization and data-driven insights, such as analyzing customer data, can help companies tailor their offerings, improve product design, and optimize pricing strategies.

Benefit of a sell-side quality of earnings report

The benefit of a sell-side quality of earnings report is to provide a consumer product company with the following:

Investor Confidence

A robust QofE report instills confidence in potential investors. It demonstrates transparency and reliability, making the company more attractive.

Higher Valuation

A thorough QofE analysis can uncover hidden value drivers and identify areas for improvement. By addressing these, the company can enhance its valuation.

Risk Mitigation

Buyers and investors want to minimize risks. A QoE report helps identify any financial irregularities or red flags, allowing the seller to address them proactively.

Streamlined Due Diligence

A readily available QofE report streamlines the due diligence process. It eliminates surprises and ensures a smoother negotiation phase.

In summary, a sell-side QofE report is a strategic asset for consumer product companies aiming to attract investors or prepare for a sale. It provides clarity, credibility, and a competitive edge in the marketplace. A sell-side QofE can increase the value of a transaction for the seller and help clarify the seller’s position on key risk areas such as inventory, customer concentration, revenue streams, seasonal revenue fluctuations, and other industry-specific significant business areas. In the dynamic world of consumer products, where market trends shift quickly, a QofE report provides stability—guiding companies toward sustainable growth. So, whether preparing for a sale or attracting investors, embrace the power of QoE to unlock value and navigate a transaction confidently.