If you are a startup founder, you will need to be able to manage three situations.The first scenario is when you decide to raise a Series A round and the subsequent VC rounds. Next, you will do a strategic purchase and finally, you will sell your company.This article will provide a framework to help you think and organize your QofE. It will also cover the most important items you'll need to remember for any M&A or private equity transaction.What is the point of QofE?QofE is a process that adjusts the reported EBITDA in order to calculate a restated EBITDA which best represents the company's current state on an ongoing basis. It also provides historical adjusted EBITDA which is comparable over the past two or three years.Three main reasons QofE can impact a company's valuation are:A buyer/investor will use the adjusted EBITDA as a basis for valuation (for companies that are valued on an EBITDA multiple). To recalculate effective growth rates, the adjusted revenue will be used. Forecasts will be based on the adjusted revenue and EBITDA.Every entrepreneur should be able to calculate the adjusted EBITDA and adjusted revenues of their company. In M&A, founders often don't understand the concepts of QofE or leave value.A professional transaction advisory team will review all documents in a data area to determine the quality of the earnings.This breakdown will help you avoid being that founder, and to make sure you are able to negotiate your company's valuation with your investors on an equal footing. You will have the benefit of understanding the thinking of an experienced buyer or investor if you're in the sellers' shoes. You will benefit from better understanding and valuing the acquisitions if you are in the buyers' shoes.What is the professional way to perform a QofE?A professional transaction advisory team will review all documents in a data space to determine the quality of earnings. These documents include, but not limited to, legal documentation, financial statements (P&L and balance sheet, cash flow), audit report, management presentation, contracts, and other information.It is important to ask yourself the following questions when performing a QofE analysis: Does this information translate into an adjustment in revenue, EBITDA, net operating capital (NWC), or net debt?NWC and net interest were included because they are important. Because they can have an indirect effect on adjusted EBITDA. Consider an adjustment to historical inventory levels. A lower inventory level means less storage costs. If you need to adjust historical inventory, make sure you also adjust your adjusted EBITDA.Interviewing managers will be a key part of your QofE analysis. You won't be able draw any meaningful conclusions or understand the numbers no matter how many times you examine the financials.How to efficiently build your QofE
