The most expensive mistake in a sale process is starting one before your financials can survive diligence. Acquirers will retract bids, request retrades, or walk away entirely when financial diligence surfaces issues. The fixes that take you three months under contract take three weeks if you do them before the process begins.
This is the technical playbook. What acquirers actually examine, in roughly the order they’ll examine it.
The Quality of Earnings (QoE) analysis
The first formal diligence workstream. Acquirers hire an accounting firm to produce a QoE report — a normalized view of the company’s earnings, stripped of one-time items, owner-specific expenses, and accounting quirks. The result is “adjusted EBITDA” — the number on which the purchase price is typically based.
What gets adjusted:
One-time expenses. Legal fees from a settlement, severance from a layoff, costs of the sale process itself. Add back to EBITDA.
Owner compensation. If the founder is paid below market and equity is the real comp, EBITDA is overstated. If overpaid, understated. Normalize to market rate for the role.
Non-recurring revenue. Special pricing for a friend’s company, one-time setup fees being recognized as recurring, pull-forward of revenue from future periods. Strip out.
Accrual vs cash differences. Deferred revenue treatment, unbilled receivables, accrued expenses that weren’t properly booked. Often the largest adjustment category and the one most likely to surprise sellers.
Pro forma adjustments. Run-rate adjustments for hires made during the period, contract terms that changed mid-year, etc.
What sellers can do before QoE: run an internal version of the analysis. Identify the adjustments in advance. Provide your view in the data room rather than having the buyer’s QoE provider build it from scratch.
Working capital normalization
Most asset purchases include a “working capital target” — a defined amount of working capital that’s expected to transfer at close. If actual working capital at close is below target, the buyer gets a price reduction. Above target, the seller gets a payment.
The math of working capital includes accounts receivable, inventory, accounts payable, accrued liabilities, and deferred revenue. The target is usually a 12-month trailing average.
Why this matters: deferred revenue in SaaS deals can swing working capital significantly. A company that just collected an annual prepay has high deferred revenue (a liability) and low working capital. If the WC target is set at a non-prepay-heavy time, the seller gets surprised at close.
How to prepare: model working capital for the last 24 months. Understand its volatility. Negotiate WC target methodology before signing the LOI, not at close.
Revenue recognition cleanup
If your revenue recognition is wrong, acquirers will adjust it — and the adjustment usually reduces EBITDA. ASC 606 issues are the most common: improperly recognized setup fees, contract modifications not properly accounted for, variable consideration estimated inconsistently.
For SaaS specifically, watch for:
- Setup fees recognized in the period collected rather than ratably (almost always wrong).
- Multi-year contracts with annual price escalators where revenue is being recognized straight-line rather than reflecting the escalator schedule.
- Customer-specific customizations that should be a separate performance obligation.
- Reseller and partner revenue with incorrect principal-vs-agent determinations.
If you have any ASC 606 fragility, identify it now. The fix is usually a restatement of historical revenue with a memo explaining the methodology. Acquirers respect this; they don’t respect being surprised by it.
Customer concentration analysis
Acquirers want to know: if your top customer churned, what happens to revenue and margin?
The standard analysis: top 5, top 10, and top 20 customers as a percentage of revenue, with each customer’s ACV, contract term remaining, renewal date, and churn risk assessment.
Red flags acquirers look for:
- Any single customer above 15% of revenue → significant valuation discount
- Top 5 customers above 50% of revenue → significant discount
- Customers near contract expiration without renewal commitments → questions about whether the business is being puffed up for sale
- Customers on month-to-month contracts disguised as recurring revenue → questions about revenue quality
How to prepare: build the analysis yourself. If concentration is a problem, decide whether to actively diversify before sale or accept the discount and frame the concentration accurately.
Key-employee retention
Acquirers care about retention because integration risk is real. The diligence asks:
- Are key employees under non-competes? Are they enforceable in their jurisdictions?
- Do key employees have meaningful unvested equity that creates retention incentive?
- Are there “founder vesting” issues — i.e., founders who haven’t vested into their equity but might leave after a sale?
What sellers should do: identify the 5-10 people whose departure would meaningfully impair the business. Make sure their contracts are clean. Understand which acceleration provisions kick in on a sale — single-trigger, double-trigger, none.
IP and contract review
The most common surprises:
- Contractor agreements without IP assignment language. Engineers working as 1099s for the first year of the company, without proper IP assignment, can be a serious diligence issue.
- Open-source compliance. Code with GPL or AGPL licenses incorporated into proprietary products without compliance review.
- Customer contracts without assignment language. Some customer contracts prohibit assignment without consent — meaning the acquirer needs every customer’s permission to acquire you. Painful and expensive.
- Patents that aren’t actually owned by the company. Inventors who left before formally assigning IP. Patent applications filed in personal names.
Run an IP and contract audit before going to market. Surprises in this category have killed more deals than any other single issue.
Customer concentration’s quieter cousin: revenue concentration by geography or vertical
Even if no single customer is dominant, concentration in a single industry or geography creates risk. If 80% of your revenue is from regional banks and bank consolidation accelerates, the buyer is acquiring a deteriorating revenue base.
Surface this analysis proactively. It’s better to acknowledge and explain than to have it surfaced by a buyer’s analyst three weeks into diligence.
The pre-process clean-up timeline
If you’re considering a sale process in the next 12 months, here’s the timeline:
12 months out:
- Engage external accounting to assess QoE-readiness.
- Address any revenue recognition issues.
- Begin clean-up of contractor IP assignments and OSS compliance.
6 months out:
- Compile customer concentration analysis.
- Document key processes and operating procedures.
- Clean up cap table — convert outstanding convertibles, document any side letters, confirm all equity has been properly granted.
3 months out:
- Build the data room: financials, contracts, IP register, employee agreements, cap table, customer concentration analysis.
- Conduct internal QoE analysis.
- Identify and brief the deal team — typically founders, head of finance, GC, and a banker if engaging one.
At the start of the process:
- Refresh financials through most recent month.
- Update customer pipeline and renewal forecast.
- Prepare management presentations.
We help venture-backed startups prepare their financials for diligence — whether for an active sale process, an opportunistic conversation, or a future raise that will have its own diligence requirements. Most of this work also improves the company while you continue operating.