Under licensing understates software cost and flatters margin. A quality of earnings review that skips the software dimension reports an earnings base the buyer cannot rely on, and pays a multiple on it.
Software risk in the quality of earnings analysis is where licensing exposure stops being a footnote and starts moving the number the deal is priced on. A quality of earnings review, often shortened to a QofE, tests whether reported profit is real, recurring, and sustainable. Software licensing touches all three. Understated licence and maintenance costs flatter margin, a looming true up threatens future profit, and a one off settlement distorts a single period. A QofE that ignores the software dimension reports an earnings base that the buyer cannot actually rely on.
The purpose of a QofE is to establish a normalised, sustainable earnings figure, because that figure usually drives the valuation through a multiple. Anything that makes reported earnings look better than the sustainable reality is a quality issue. In the software dimension, the most common quality issue is a licensing cost base that is too low because the target is under licensed. The target appears to spend less on software than a compliant peer, so its margin looks stronger, but that margin is borrowed from a future true up that has not yet arrived. Correcting for it lowers normalised earnings and, through the multiple, the price.
This is why the software exposure has to be examined specifically rather than assumed to be inside the general financial review. A standard QofE team will test the recorded costs, but it is not equipped to compare deployment against entitlement and detect that the recorded software cost is artificially low. That gap is exactly where inherited exposure hides, and it is the reason a quantified software view, set out in quantifying cost to cure for the deal model, belongs alongside the QofE.
Software risk produces several distinct adjustments in a QofE, and they should be kept separate because they affect the model differently. A recurring under spend on licences and maintenance is a sustainable cost adjustment that reduces normalised EBITDA period after period, and it is the one that moves the price most through the multiple. A one off settlement already incurred is a non recurring item that should be added back to normalised earnings but recognised as a cash cost. A pending true up that has not yet crystallised is a contingent liability that belongs in the net debt or completion mechanism rather than in earnings. Confusing these three is a common and expensive error.
The relationship between the QofE adjustment and the broader EBITDA treatment is set out in software licensing and EBITDA adjustments, and the way the resulting risk feeds the headline valuation is covered in how software risk affects deal valuation. The point of separating the items is to ensure each one lands in the right place in the model, so the buyer neither double counts nor misses an exposure.
| Item | QofE treatment | Effect on the model |
|---|---|---|
| Recurring under spend on licences | Reduce normalised EBITDA | Lowers price through the multiple |
| One off settlement already paid | Add back as non recurring | Recognised as a cash cost |
| Pending true up not crystallised | Contingent liability | Net debt or completion item |
| Maintenance underfunded | Normalise to compliant level | Lowers sustainable margin |
| Renewal repricing at change of control | Forward cost adjustment | Affects forecast not history |
Timing matters. The software analysis has to reach the QofE team before the normalised earnings figure is locked, because once the multiple is applied to a number, unwinding it in negotiation is hard. A buyer who commissions the software view late finds the exposure surfacing after the valuation has been set, which forces a price renegotiation from a weaker position. Bringing the deployment and entitlement analysis in early lets the adjustment flow into the normalised figure cleanly, so the price reflects sustainable earnings from the outset.
The cost of getting this wrong is well illustrated by public cases. In reported disputes, SAP pursued AB InBev for a reported 600 million dollars and Diageo for a reported 60 million over disputed and inherited licensing, as of June 2026. An earnings base that quietly assumed a compliant cost structure, while the target was materially under licensed, would have carried a recurring overstatement large enough to distort the valuation. The QofE is the right place to catch it, provided the software dimension is examined and not assumed. This page is commercial advisory on the earnings analysis, not accounting or legal advice; confirm treatment with your own advisers.
The reason a software adjustment in the QofE matters so much is the leverage of the multiple. If a target is valued at, say, ten times normalised EBITDA, then a recurring software under spend of one million in a year reduces the value by ten million, not one. That leverage is what turns a seemingly modest annual licensing gap into a material change in the price. A buyer who treats the under spend as a one off cost, rather than a recurring adjustment to sustainable earnings, will undercount its effect on value by the whole multiple. The discipline is to ask, for each software item, whether it recurs, and to put the recurring ones into normalised EBITDA where the multiple applies.
This also shapes the negotiation. A seller will resist a recurring adjustment precisely because of the multiple, and will argue that the software cost is one off or already reflected. The buyer counter is the deployment and entitlement evidence showing that the estate is structurally under licensed and that bringing it to compliance is a permanent cost. With that evidence, the adjustment holds; without it, the seller frames the issue away and the buyer pays a multiple on earnings that cannot be sustained once the licensing position is corrected after close.
Software risk in the quality of earnings analysis sits within software in deal valuation, alongside EBITDA adjustments and the valuation impact. The deployment and entitlement analysis that feeds the QofE comes from software spend diligence. Engage your own counsel and accounting advisers for interpretation.
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