What was broken
A speciality manufacturer entered discussions with a private equity fund for a growth investment. The founders knew that PE diligence would be far more demanding than anything they had faced before, and their finance, tax, and compliance records were not organised to withstand that level of scrutiny.
What we did
CapEasy ran a pre-diligence readiness exercise: organising financial and tax records, closing compliance gaps, formalising related-party and governance documentation, and building the data room the fund’s advisors would examine. We flagged and remediated issues early so they would not surface as surprises during the fund’s review.
Where it landed
The company entered diligence with an organised data room and remediated records, allowing the process to move quickly and with fewer conditions. The preparation strengthened the founders’ negotiating position and investor confidence.
A quality-of-earnings review is not an audit — it asks a different question
When a US private equity fund moves toward a term sheet, it commissions a quality-of-earnings (QoE) engagement, usually run by an accounting firm the fund retains. A QoE does not re-verify GAAP compliance the way an audit does — it asks whether the EBITDA the seller is presenting is real, repeatable, and normalized. For a manufacturer, that means the reviewer walks the trailing-twelve-month P&L line by line, checks it against the general ledger, and tests every addback the seller has proposed: the one-time legal settlement, the owner’s above-market rent to a related entity, the discretionary bonus paid the year before a sale process started.
The pattern that slows a deal down is not fraud — it is addbacks that exist only as a number in a spreadsheet, with nothing behind them. A QoE reviewer treats an unsupported addback as unproven income and either strikes it from EBITDA or discounts it, and either move changes the multiple the fund is willing to pay. The fix is not clever accounting; it is a paper trail built before anyone asks for one.
Owner compensation is the addback that gets tested hardest
Manufacturers held by a founder-operator almost always carry an owner-compensation addback: the argument that a new owner would pay a market-rate general manager less than the founder currently draws, and the difference should be added back to EBITDA. The IRS has its own, adjacent version of this question for S corporation shareholder-employees — it requires reasonable compensation for services actually rendered before non-wage distributions are treated as such, and it weighs training and experience, duties, time devoted to the business, and what comparable businesses pay for the same role. A QoE reviewer runs a version of the same test in reverse: they want a market-comparable salary benchmark for the replacement role, not just the founder’s current draw and an assertion that it is "too high."
The same scrutiny lands on every related-party line: rent paid to an entity the family owns, management fees to an affiliate, purchases from a supplier under common control. Each one needs a documented market-rate comparison and, ideally, a written agreement — not a verbal understanding formalised the week diligence opens.
The close that survives a QoE is the one run every month, not reconstructed for it
A manufacturer’s books carry more moving parts than a services business — standard costing variances, work-in-process, inventory reserves, warranty accruals — and a QoE reviewer treats each as a place where "adjusted EBITDA" can quietly diverge from cash reality. The engagement’s discipline transfers directly: close every month on the same basis, reconcile inventory and cost-of-goods-sold to the general ledger rather than plugging a variance at year end, and keep the supporting schedule for every accrual and reserve so a reviewer can trace the balance back to its calculation, not just the number on the balance sheet.
The IRS’s own reasoning for why a business keeps records applies to a QoE for the same reason it applies to an audit: complete, contemporaneous records speed up an examination and incomplete ones extend it. A trailing-twelve-month EBITDA bridge assembled from twelve monthly closes that already reconcile is a review measured in weeks. The same bridge reconstructed from a single year-end close, chased back through invoices and bank statements, is where a deal timeline slips — and where a fund starts pricing in the risk of what else might not hold up.
The data room artefacts, and who reads each one
A US PE data room for a manufacturer typically groups documents the same way regardless of fund: financials (reconciled monthly statements, the QoE-ready EBITDA bridge, AR/AP aging), tax (returns, any open audit correspondence, sales and use tax filings by state), operations (customer and supplier contracts, equipment leases, warranty history), and governance (cap table, board minutes, related-party agreements). The fund’s deal team and its retained QoE accountants read the financial and tax folders first; fund counsel reads governance and contracts; and any addback claim gets tested against whichever folder it touches.
CapEasy’s part in that work is the preparation: organising the folders, reconciling the schedules, and documenting the addbacks and related-party terms before the fund asks. The QoE opinion itself, the tax filings, and any legal representations to the fund run through your CPA firm and counsel — our job is making sure the file they’re signing off on is already built.
What to take from it
- A QoE review tests whether EBITDA is real and repeatable, not whether the books are technically GAAP-compliant — an unsupported addback gets struck, not debated.
- Owner compensation and every related-party line — rent, management fees, intercompany purchases — need a documented market-rate comparison, not a verbal understanding.
- For a manufacturer, inventory, cost-of-goods-sold and warranty reserves are where adjusted EBITDA quietly drifts from cash reality; reconcile them every month, not at year end.
- Twelve monthly closes that already reconcile turn a QoE into a review measured in weeks; a single reconstructed year-end close is where a deal timeline slips.
- Build the data room before the fund asks for it — the folders a QoE team and fund counsel expect are known in advance, and gaps found early are fixes, not surprises found mid-diligence.