Quality of earnings is an analysis that tests how sustainable and accurate a target reported earnings are, normalising them to a defensible run rate.
What is quality of earnings? Quality of earnings, often shortened to QoE, is the diligence analysis that looks behind reported profit to test how durable and repeatable a target earnings really are. It strips out one off items, normalises run rate costs, and gives the buyer a defensible view of sustainable EBITDA. In software M&A a quality of earnings review intersects directly with licensing, because an unbudgeted true up or an under provisioned software run rate can flatter earnings today and become a real cost tomorrow.
A quality of earnings review normalises the costs that keep a business running, and software is one of the largest and least understood of them. If a target has been under provisioning for its true software run rate, deferring renewals, or carrying an unrecognised compliance shortfall, its reported EBITDA is overstated. A buyer pricing the deal on that EBITDA pays a multiple on earnings that will not persist. Bringing licensing analysis into the quality of earnings work corrects the run rate and surfaces the looming true up before it is capitalised into the price.
Standard quality of earnings work treats software as a line of spend. A software aware review goes further. It tests whether the current run rate is sustainable, whether renewals have been deferred to flatter margins, whether a known shortfall has been provisioned, and whether change of control terms will reprice agreements after the deal. Each of these adjusts normalised EBITDA. The result is a price built on earnings that survive contact with the combined estate rather than ones that unravel in the first renewal cycle.
The two analyses reinforce each other. The effective license position quantifies the compliance exposure, and the quality of earnings review translates the ongoing run rate impact into normalised earnings. Together they give a buyer both the one off cost to cure and the recurring cost the business will actually carry. This work is commercial and licensing advisory, not legal advice.
| Adjustment | What it tests | Effect on EBITDA |
|---|---|---|
| Sustainable run rate | Is current spend realistic | Often raises cost |
| Deferred renewals | Were renewals pushed out | Reveals hidden cost |
| Compliance shortfall | Is a true up provisioned | Adds a future charge |
| Change of control repricing | Will terms reset on close | Increases run rate |
Related reading: see the M&A software glossary hub, plus effective license position and cost to cure.
Map and quantify the licensing exposure in your target or portfolio before it becomes a post close audit. Independent, buyer side, paid only by the acquirer.
Talk to a software M&A advisor