A quality of earnings review is the buyer’s independent rebuild of your practice’s earnings, run after the letter of intent is signed and before any money moves. In a dental practice sale to a DSO, it is the review that decides what you are actually paid. The letter of intent prices the practice off a number. The quality of earnings review tests whether that number is real, and the price follows the test. Most owners hear the phrase for the first time the week the buyer’s accountants send their document request, which is roughly three months too late to change the outcome.
I spent over four years running the M&A team at one of the country’s largest DSOs. We reviewed more than a thousand practices, closed more than 50 transactions, and put over $500 million in deal value through the diligence process I ran, which meant working alongside the outside quality of earnings firms on every one of those closed deals and deciding, with them, what the earnings really were. This post is the list the team on the other side is working from. If you are earlier in your thinking, start with our complete guide to selling your dental practice and come back when you have an offer to defend.
What a Quality of Earnings Review Is, and Who Runs It
Start with what it is not. It is not an audit. An audit gives an opinion on whether your financial statements follow accounting rules. A quality of earnings review does not care much about your statements. It cares about one number, the earnings a new owner can count on, and it rebuilds that number from your records up.
On most DSO deals the buyer does not run the review in house. It commissions an outside accounting firm, and in many cases it has no choice: the buyer’s lender or its private equity sponsor requires an independent report before the deal can fund. That firm works directly with you and your advisor. It sends document requests, schedules calls, asks follow-up questions, and delivers its report to the buyer. Once it is done, the buyer’s team walks you through it: the adjustments, line by line, and where its number differs from yours and why. You see the differences; what you do not control is the firm, the timing or the standard it applies.
Financial diligence is one of several streams running at the same time. There is usually a clinical chart review, a legal review of your entity, lease and contracts, a payor and credentialing check, and an operational look at your team and systems. Those can slow a deal down or add conditions. The quality of earnings review is the stream that moves the price, and it is the longest pole in the roughly 90 days between a signed letter of intent and closing that I walked through in the month-by-month timeline.
If you have an unsolicited offer in hand, this review is already in the buyer’s plan. Groups that approach owners directly run the same diligence as groups that win a process. The difference is whether you have prepared for it or are hearing about it from them.
Why It Happens After You Sign
Sellers often ask why the buyer does not do this work before making an offer, and the answer is cost and sequence. An independent review is expensive and slow, and no buyer commissions one on a practice it has not locked up. So the letter of intent comes first, built on your numbers and the buyer’s own internal pass, and the real test comes second, inside an exclusivity period during which you have agreed not to talk to anyone else.
That sequence is where the leverage sits, and it is why the way the letter of intent states its price matters more than the headline. Offers come in two shapes. One is a fixed price, conditioned on the review verifying the earnings it was built on. The other is a formula: a multiple of the earnings the review adjusts and verifies, so the price is not known until the review is done. Both can end in a retrade. Under the formula the repricing is arithmetic, a smaller verified number times the same multiple. Under the fixed price the number was conditional from the start, and a miss opens it back up. Many letters state the shape without stating the earnings: measured when, with whose adjustments, re-measured at close or not. I covered that as the most expensive ambiguity in the document in the post on letter of intent red flags. Read together, the two documents work like this: the letter of intent sets the terms of the price, and the quality of earnings review supplies the number those terms are tested against.
None of that is a trick. It is how every institutional buyer in the country works, and the sellers who do well with it are the ones who treat the review as the real pricing event and prepare for it as such.
What the Quality of Earnings Team Hunts For in a Dental Practice
Every firm has its own template, but having sat across from the reports for years, the work falls into the same areas in roughly the same order. This is the list, in that order.
Revenue that ties three ways. The first thing the team does is reconcile collections in your practice management software to deposits in your bank statements to revenue on your profit and loss. Revenue that ties all three ways is real. Revenue that does not gets explained or gets removed. The usual culprits are not fraud. They are patient refunds and credit balances sitting in the practice management system, adjustments and write-offs posted inconsistently, and deposits that landed in a different month than the production they belong to. Patient credit balances in particular are money you owe, and the team will treat them that way.
The trend, month by month, including the months since you signed. The team is not buying a twelve-month total. It is buying a direction. It lays out your trailing twelve months by month, compares them to the prior year, and then checks the months that have passed since the letter of intent. This last part surprises owners every time: the review is partly a performance check on whether you kept producing while the deal came together. In our experience, a quality of earnings miss is one of the leading reasons a buyer reprices a deal or walks away from it, and a trend that softens after signing is the most common way the miss shows up. A slow quarter after the letter of intent is not a detail. It is a repricing. The short version of what to do about it is in a post I wrote in September, You signed the LOI. Don’t take your foot off the gas. Run the practice exactly as you did the day before you signed: keep the schedule full and hygiene recall on, do not push the big cases to the new owner, keep your billing and collections cadence the same, and keep the sale confidential with the team, because a practice that senses a change starts producing like one.
Every add-back, at the transaction level. This is where the most money moves, and it is the subject of its own post on why DSOs reject add-backs. The team pulls the general ledger detail behind every adjustment on your add-back list and asks three questions of each: can it be proved, is it truly non-recurring, and does the cost actually disappear under new ownership. Items that pass stay in earnings. Items that fail leave, and a list with several failures costs the rest of the list the benefit of the doubt.
Provider economics. The team breaks production out by provider and asks what it costs to replace the owner’s clinical work at a market rate. If you have been paying yourself less than that rate, the review adds the difference back as a cost, and your earnings fall. If you have an associate, the team tests whether that associate’s compensation matches the associate’s production and whether the arrangement survives a change of ownership. Hygiene production gets the same look: how much of it there is, and whether it depends on you.
Payroll, as it actually ran. Payroll registers get tied to the profit and loss line by line. The team is looking for bonuses that were paid but not booked as compensation, family members on payroll whose roles would need to be filled, contractors on a 1099 who function as employees, and paid time off that has been earned but not taken. Each one is an adjustment, and most of them run against the seller.
Accounting basis and cutoff. Most practices keep cash-basis books, which is fine for taxes and misleading for earnings. The team converts the picture to something closer to accrual: expenses matched to the months they belong to, prepaid treatment and orthodontic contracts treated as obligations rather than income, a December supply order spread across the year it was bought for. This is the one area where the adjustments regularly run in the seller’s favor, because a practice that pays its bills early and books its revenue late looks worse on a cash basis than it is.
Related parties and the recurring one-time expense. If you own your building, the team restates rent to a market rate, in whichever direction the market points. Vendors owned by family, management fees paid to your own entity, and loans between you and the practice all get unwound to arm’s length. Then the team scans three years of ledger for the one-time expense that happens every year: the repair, the recruiting fee, the marketing push. Those stay in as costs of running the practice.
What transfers and what stays with you. Nearly every dental practice deal is an asset purchase, so the working capital mechanics you read about in big-company mergers are not part of it. What the team does pin down is the line between the two sides: cash and the receivables you earned before closing usually stay yours, prepaid treatment and orthodontic contracts are obligations that travel with the patients, supplies on hand are counted, and the purchase agreement says who collects your pre-close receivables after closing, at whose cost, for how long. None of that is a price adjustment. All of it is money, and the team wants the line clean before anyone signs the final document.
How the Report Travels Back Into Your Price
The report lands with the buyer’s deal team first, and then the team walks you through it. What it contains, at its heart, is a bridge: the earnings you presented at the top, each adjustment the review made as a line, and the earnings the firm will stand behind at the bottom. The deal team drops that bottom number into the same model that produced the letter of intent, and the model does what models do.
With illustrative numbers: if the letter of intent priced the practice by formula at 7x and the review removes $60,000 of add-backs it could not support, the price moves by $420,000. Nobody renegotiated. Nobody acted in bad faith. The formula simply multiplied a smaller input. Under a fixed-price letter the same $60,000 does not move the price by arithmetic; it reopens the price, because the number was conditioned on the review confirming the earnings, and the conversation that follows is a retrade. Either way, the deal team is now walking you through a lower number with the report in hand, and the lines you can answer with a document are the only lines that move back.
That is the moment to understand who you are dealing with. The business development team that brought you the offer has spent months on your deal and wants it to close, and their names are on the memo that goes up for approval, so they are also the people who cannot sign off on earnings the report would not. I wrote about that memo and the five questions behind it in the post on what a DSO investment committee actually asks. The first question is whether the earnings are real, and the quality of earnings report is how it gets answered.
Three outcomes are possible when the bridge is done. If the verified number lands within a normal tolerance of the number in the letter of intent, the deal closes at its price. If it lands below, the buyer re-cuts the price, adds a holdback or an earnout to cover the gap, or both. If it reveals something the buyer did not expect at all, a decline in the trend or a provider arrangement that will not transfer, the buyer may walk. The further the bridge has to travel, the more likely the second and third outcomes become, and the only way to shorten the bridge is to have built the top number to the same standard the firm will apply to the bottom one.
How Long Does a Quality of Earnings Review Take?
Several weeks, and the single biggest variable is you. The firm sends document requests in waves. Every request that sits for a week adds a week to closing, and every answer that has to be reconstructed invites two more questions. Sellers whose records were built to buyer standards tend to move through the review in a matter of weeks and close inside the normal 90 days from a signed letter of intent. Sellers rebuilding their books under deadline pressure live in it for months, and a long review is itself a risk, because it gives the trend more time to move and the buyer more time to think.
Who Pays for the Quality of Earnings Review?
The buyer pays for its own review, always. It is the buyer’s report, commissioned for the buyer’s lender and the buyer’s approval process; once it is complete the buyer walks you through it, so you see where its number differs from yours and why, but the firm answers to the buyer, not to you.
Some sellers commission their own version before going to market, a sell-side quality of earnings report from an independent firm, and hand it to buyers with the offering materials. For a practice in the range that groups compete for, the logic is simple: the review is going to happen either way, and a seller who has already found and fixed the problems is negotiating from a verified number instead of a hoped-for one. Whether a full report is worth the cost or whether the same standard can be met by your advisor building the package to buyer specifications is a judgment call that depends on the practice. What is not a judgment call is doing one or the other.
What the Prepared Seller Does Before the Letter of Intent
Everything above compresses into a short list of work, and all of it happens before anyone has signed anything. Most of it is in the pre-sale playbook, which lays out the full year before a sale. The version for this review specifically:
- Assemble the four documents the buyer’s team will ask for first, for the same twelve closed months: the trailing twelve months of profit and loss by month, the general ledger, production and collections reports from your practice management system, and a payroll summary. If those four tie to each other, you are ahead of most sellers before the first call.
- Tie your own revenue three ways before they do. Practice management collections to bank deposits to the profit and loss, month by month. Find the gaps and write down the reasons. Clear old patient credit balances.
- Document every add-back at the transaction level and claim it at the delta. Ledger entries, invoices, dates. If a line is arguable, leave it off; its face value times the multiple is worth less than your credibility times the whole list.
- Normalize your own compensation before the review does it for you. Know the market rate for your production and present earnings with that correction already made. It converts the most common repricing in dental deals into a credibility signal.
- Close your books monthly and keep producing after you sign. The trend is being measured through closing. A practice that coasts after the letter of intent hands the buyer a reason it did not have before.
- When the bridge arrives, argue documents, not stories. Ask the deal team for the adjustments line by line. The ones you can answer with a ledger entry or an invoice are recoverable. The ones you can answer only with an explanation generally are not.
Find Out What Survives Before a Buyer Does
The quality of earnings review is the one part of a sale where the buyer’s answer and your answer are supposed to be the same number. When they are not, the difference comes out of your proceeds, and it comes out at the point in the process when your alternatives have already moved on.
That is what our free practice valuation is built for. It reads your practice the way the buyer’s diligence team will: which add-backs survive, what your earnings look like after normalization, where your revenue does not tie and why. You see the bridge before a buyer builds it, while there is still time to change what is at the top of it. No obligation, and no listing pitch. The sellers who do well in diligence are not lucky. They did this part first.