Public Commentary: The frameworks and ranges cited below reflect FG Capital Advisors’ leveraged-finance experience. They do not constitute investment advice or a solicitation.
Quality of Earnings (QoE) Impact on Debt Capacity in Private Acquisitions
In mid-market M&A, purchase-price multiples are negotiated off adjusted EBITDA, but lenders rely on an independently prepared Quality-of-Earnings (QoE) report to validate those adjustments. A favourable QoE that uplifts EBITDA by even 5 % can translate into an additional half-turn of leverage—often the difference between closing and renegotiating price. Conversely, negative findings erode debt capacity and force sponsors to inject more equity. Understanding how QoE outcomes flow through lender credit models is therefore essential.
Typical QoE Adjustments and Leverage Impact
| Adjustment Category | Leverage Effect |
|---|---|
| Revenue Recognition Corrections Shift from bill-and-hold to upon-delivery, etc. |
Reduces LTM EBITDA; leverage multiple applied to smaller base → lower debt quantum. |
| Non-Recurring Expenses Legal settlements, ERP roll-out, severance. |
Increases adjusted EBITDA; may justify 0.25–0.5× extra leverage if cash savings are verifiable. |
| Working-Capital Normalisation One-off inventory build-up, payables stretch. |
Drives additional revolver needs; lenders may haircut term-loan sizing to protect liquidity. |
| Customer Concentration Risks Top-three customers >50 % revenue. |
Triggers leverage cap or step-down covenants irrespective of EBITDA level. |
| Pro-Forma Synergies | Lenders typically give credit for 50–70 % of management-identified synergies; affects term-loan sizing. |
How Lenders Translate QoE Findings into Debt Capacity
- Adjusted EBITDA Benchmark: Base-case credit model starts with lowest of management, auditor, or QoE EBITDA.
- Leverage Multiple Range: Senior debt 2.5–4.0×; total leverage 3.5–5.5× depending on sector and cash-flow stability.
- Cash-Conversion Ratio: QoE cash-flow bridge to validate EBITDA-to-cash conversion ≥80 %.
- Stress Case: EBITDA haircut 15–20 % and working-capital swing; minimum debt-service coverage ≥1.2×.
- Covenant Calibration: Initial leverage covenant set 0.25–0.5× above funded level; step-downs post integration.
Sensitivity Example
Target company EBITDA scenarios (US$ millions):
| Management Adj. | QoE Base Case | QoE Downside | |
|---|---|---|---|
| EBITDA | 20.0 | 18.5 | 16.0 |
| Senior Debt @3.5× | 70.0 | 64.8 | 56.0 |
| Equity if Purchase Price = 8× mgmt EBITDA | 90.0 | 95.2 | 104.0 |
A US$3 million downward QoE adjustment increases required equity by US$14 million.
Mitigating Negative QoE Outcomes
- Seller Notes or Deferred Consideration: Bridges valuation gap without immediate cash.
- Equity Cure Rights: Provide headroom if covenants tighten post-closing.
- Targeted Covenants: Substitute customer-concentration caps for lower leverage if risk is idiosyncratic.
- Additional Collateral: Pledge real estate or equipment to secure incremental term loan.
Process Timeline (Signing to Funding)
Day 1–9
— LOI executed
Day 10–25
— QoE fieldwork & draft report
Day 26–30
— Lender term sheet updated
Day 31–45
— Final credit approval & legal documentation
Day 46–60
— Funding & acquisition close
Engagement
Sponsors planning a leveraged acquisition are encouraged to engage FG Capital Advisors early in the QoE process. Our team translates diligence findings into lender-ready models, maximising achievable debt while preserving closing certainty.
This document is intended for informational purposes only. It does not constitute investment advice or an offer to purchase or sell any security or service. Independent professional guidance is recommended before relying on any information herein.
