When a buyer makes an offer for a SaaS company, the price is usually a multiple of ARR or earnings, subject to diligence. The diligence that most often changes price is the quality of earnings (QoE) review: an accounting firm's analysis of whether reported revenue and earnings are real, recurring and correctly measured.
What a QoE examines
| Area | Questions |
|---|---|
| Revenue quality | Does revenue follow ASC 606? Is ARR supported by contracts and billing? How concentrated are customers? |
| Retention | Do cohorts and NRR hold up when rebuilt from billing data? |
| Adjusted EBITDA | Are add-backs for one-time and non-cash items supported? |
| Cost of revenue | Is hosting and support fully captured? What happens to margin at scale? |
| Cash conversion | Does cash follow earnings? |
| Net working capital | What is normal, and what is the target at closing? |
| Debt and debt-like items | What reduces the equity value? |
| Tax exposure | Sales tax nexus, payroll in uncovered states, income tax filings |
Adjusted EBITDA
| Amount | |
|---|---|
| GAAP net loss | −$400,000 |
| Add: interest, taxes, depreciation and amortization | +$350,000 |
| EBITDA | −$50,000 |
| Add: stock compensation | +$600,000 |
| Add: one-time legal costs of a settled dispute | +$120,000 |
| Add: founder compensation above market (if replaced) | +$80,000 |
| Adjusted EBITDA | $750,000 |
Each add-back needs documents. Buyers often reverse add-backs that recur ("one-time" costs that happen every year) or that a new owner would still incur.
Net working capital
The purchase agreement usually sets a working capital "peg," often based on a trailing average. If working capital delivered at closing is below the peg, the price goes down dollar for dollar; above it, up. For SaaS companies, how deferred revenue, accrued bonuses and unbilled receivables are treated drives the result.
Debt-like items
Buyers deduct items that behave like debt: loans, unpaid taxes, accrued but unpaid bonuses, deferred compensation, and sometimes deferred revenue or customer credits. Agree on the list early.
Structure and tax
In an asset purchase, the price is allocated among asset classes and both buyer and seller report it on Form 8594. Stock purchases and mergers carry different consequences for the seller, including whether QSBS treatment applies to the gain. Larger transactions may also require a premerger notification filing with the FTC and the Department of Justice.
Preparing before the process
- Two or more years of monthly GAAP financials, closed and reconciled
- ARR bridge and cohorts tied to billing and revenue
- Revenue recognition memo and deferred revenue roll-forward
- Sales tax nexus study and any voluntary disclosures completed
- Cap table reconciliation and option treatment in the deal modeled
- A sell-side QoE, or at least a readiness review, before the letter of intent
We prepare the financials and schedules a QoE provider tests, support the founder through diligence requests, and model working capital and debt-like items before the letter of intent is signed.
Sources
- IRS, About Form 8594, Asset Acquisition Statement
- Federal Trade Commission, Premerger notification program
- FASB Accounting Standards Codification, Topics 606 and 805
- 26 U.S.C. §1202 (Cornell LII)
Questions founders ask
Should the seller commission its own quality of earnings report?
Many sellers do, especially in competitive processes. A sell-side report finds issues early, frames adjustments with support, and shortens the buyer's own review.
Is deferred revenue debt in a sale?
It is negotiated. Buyers sometimes argue deferred revenue is a debt-like item because they must deliver service with no further cash. Sellers argue it is normal working capital. The answer belongs in the letter of intent, not at closing.
