In every M&A deal — especially founder-led exits — there’s always one moment where things start to feel a little… tense.
The deal team starts digging into the revenue recognition, deferred revenue balances, and accrual accounting.
If you’re not prepared, this is where seemingly small accounting issues can knock millions off valuation, extend diligence timelines, and shift deal structure heavily toward the buyer.
As I regularly emphasize to founders at Legacy Advisors — and as we explore deeply in The Entrepreneur’s Exit Playbook (available here) — deferred revenue and accrual accounting aren’t just financial statements topics. They’re exit levers that directly affect purchase price, closing risk, and post-deal obligations.
In this article, I’ll break down why buyers care so much about deferred revenue and accruals, where founders often get tripped up, and how you can get ahead of these issues long before diligence starts.
Why Deferred Revenue and Accruals Matter in M&A
Let’s simplify:
- Deferred Revenue represents revenue you’ve been paid for but haven’t yet delivered (or earned) according to accounting rules.
- Accruals reflect earned revenue or incurred expenses that haven’t yet hit your cash accounts.
In M&A, these two concepts become important because:
- Buyers want to ensure they’re not double-paying for services they’ll have to deliver post-close.
- Buyers underwrite cash flow timing carefully when setting purchase price and structure.
- Deferred revenue obligations often require negotiation around working capital true-ups and purchase price adjustments.
- Sloppy recognition creates trust erosion during financial diligence.
The Founder’s Misconception: “Cash = Revenue”
Many founder-led companies operate primarily on a cash basis early in their lifecycle. That’s fine for bootstrapping — but creates major problems when buyers shift into GAAP-based diligence.
If you receive $1M upfront for a 12-month contract, your financials may show:
- $1M revenue booked on receipt (cash basis), but
- Only $83K/month earned (accrual basis over the contract term).
In an exit, buyers want economic accuracy — not cash receipts.
Deferred revenue represents future service obligations. Buyers carefully analyze how much of your reported revenue was earned vs. pre-paid.
How Deferred Revenue Impacts Valuation
The bigger your deferred revenue balance, the more buyers scrutinize:
- Whether revenue has been properly recognized
- Whether contracts align with revenue timing
- How much cash they’re inheriting tied to post-close service delivery
Poor deferred revenue accounting creates two valuation risks:
1️⃣ Overstated EBITDA
If you recognize prepaid revenue too early, your EBITDA may appear artificially inflated. Buyers will adjust normalized EBITDA downward during QoE.
2️⃣ Working Capital Negotiations
Deferred revenue liabilities often get carved out of working capital true-ups — meaning you may receive less cash at close if obligations are significant.
Where Deferred Revenue Kills Trust
I’ve personally seen deals at Button Holdings where deferred revenue caused:
- $3–5M purchase price adjustments
- 60–90 day diligence delays
- Expanded escrow and indemnification holdbacks
- Buyer walkaways if misstatements felt intentional
Not because the business wasn’t valuable — but because financial credibility broke down.
Accruals: The Other Hidden Landmine
Beyond deferred revenue, accrual accounting issues cause:
- Timing mismatches between revenue and expenses
- Artificial margin swings between reporting periods
- “Lumpy” EBITDA fluctuations that scare buyers
- Misaligned revenue recognition vs. customer delivery schedules
Accrual discipline is what allows buyers to compare apples-to-apples financial periods and underwrite sustainable margins.
SaaS & Subscription Models: Extra Deferred Revenue Sensitivity
For SaaS, deferred revenue scrutiny is even more intense because:
- Buyers value ARR and NRR heavily in valuation models.
- Revenue recognition errors directly distort these metrics.
- Investors analyze churn cohorts, expansion revenue, and contract start dates.
If your deferred revenue schedules don’t match actual contract timing, buyers fear:
- Churn is higher than reported.
- ARR is overstated.
- Revenue growth isn’t sustainable.
The result? SaaS buyers become hyper-cautious, adjusting both valuation and structure to compensate for forecasting uncertainty.
The Private Equity Lens on Deferred Revenue
PE buyers pay particular attention because:
- Deferred revenue affects debt service capacity post-close.
- Lenders require detailed deferred revenue audits.
- Debt-to-EBITDA calculations depend on normalized accrual accounting.
PE funds simply won’t finance deals with messy deferred revenue — period.
Case Study: How Deferred Revenue Cost a Founder $6M
We advised a founder-led services company preparing to sell at ~$35M enterprise value.
During QoE:
- Deferred revenue was overstated by $1.2M
- Service delivery obligations hadn’t been properly offset
- Margin was artificially elevated by ~7% over 18 months
The buyer’s diligence team:
- Adjusted normalized EBITDA downward
- Lowered purchase price by ~$6M at a 5x multiple
- Increased holdback escrow to cover deferred revenue true-up risk
All entirely avoidable — had deferred revenue been documented cleanly upfront.
How Buyers Analyze Deferred Revenue in Diligence
| Buyer Diligence Questions | Why They Matter |
|---|---|
| Do contracts match revenue recognition timing? | Validates earned vs. unearned revenue |
| How is deferred revenue tracked across periods? | Prevents revenue double-counting |
| Are prepayments refundable? | Reveals hidden liabilities |
| Is revenue being recognized ratably or upon delivery? | Affects margin and forecast modeling |
| How does deferred revenue reconcile to cash? | Impacts working capital negotiations |
Buyers bring sophisticated forensic accounting teams to this analysis — especially above $10M EBITDA.
The Legacy Advisors 24-Month Deferred Revenue Rule
Like most financial preparation, deferred revenue cleanup should start 24 months before exit.
Here’s how we advise founders:
| Timeline to Exit | Action |
|---|---|
| 24 months | Shift to accrual-based GAAP reporting |
| 18 months | Reconcile historical deferred revenue schedules |
| 12 months | Conduct internal audit of revenue recognition policies |
| 6 months | Build buyer-ready deferred revenue workbook for diligence |
The earlier you address issues, the cleaner your QoE process will be.
Deferred Revenue & Working Capital True-Ups
In most deals, deferred revenue sits outside the working capital peg calculation because:
- The buyer inherits both cash and service obligations.
- Buyers don’t want to pay twice: once at close and again via service delivery.
Negotiating deferred revenue treatment requires:
- Clear documentation of contract start/end dates
- Service delivery schedules
- Refundability status
- Revenue recognition policies
Founders unprepared for these true-up debates often leave cash on the table unnecessarily.
Podcast Insight: Control Deferred Revenue Before It Controls Your Deal
As I’ve shared with founders regularly — including in episodes of the Legacy Advisors Podcast (listen here) — you don’t want to start learning about deferred revenue during buyer diligence.
By then, it’s too late. You’ve lost narrative control.
Deferred revenue should be packaged and defensible before you engage buyers — not negotiated under pressure after LOIs are signed.
The Working Capital Trap Founders Miss
One of the most painful surprises founders face late in deals:
- Working capital shortfalls triggered by deferred revenue misclassification.
Example:
- Deferred revenue should’ve been excluded from current liabilities.
- Buyer includes it in working capital peg.
- Founder receives $500K less cash at close.
Even experienced founders can get tripped up here if they haven’t built deferred revenue prep into early exit planning.
The Entrepreneur’s Exit Playbook Guidance
In The Entrepreneur’s Exit Playbook (available here), we emphasize that exit value isn’t just driven by top-line growth or margin — it’s protected by financial discipline long before buyers arrive.
Deferred revenue and accruals are some of the most technical — but entirely controllable — elements founders can proactively address to de-risk valuation.
The Founder Mindset Shift
Many founders tell themselves:
“We’ll clean that up once diligence starts.”
Instead, adopt this mindset:
“Deferred revenue is one of the few deal risks I can fully control — and I’ll do it early.”
By controlling deferred revenue now, you control:
- Valuation
- Structure
- Diligence timeline
- Buyer confidence
- Closing certainty
Final Thoughts
Deferred revenue and accruals don’t get a lot of founder attention — until it’s too late.
But for serious buyers, these issues:
- Drive valuation adjustments
- Extend deal timelines
- Expand deal structure complexity
- Shift negotiating leverage
The founders who engineer premium exits don’t wait to defend their numbers — they build financial stories so clean that buyers never feel the need to question them.
Because in M&A, the best financial story isn’t one you explain — it’s one buyers simply believe.
Frequently Asked Questions About The Role of Deferred Revenue and Accruals in Exit Strategy
Why do buyers focus so heavily on deferred revenue during M&A diligence?
Because deferred revenue directly reflects future obligations that the buyer is inheriting. Buyers don’t want to pay full value for revenue that has already been collected but not yet earned. Deferred revenue tells buyers how much of the purchase price they’re effectively paying in advance for services they will still have to deliver post-close. As Ed Button, Jr. teaches at Legacy Advisors, when deferred revenue isn’t properly recognized or documented, buyers fear they’re paying twice — once at closing and again in post-close service delivery. That uncertainty often results in valuation adjustments and tighter deal structures.
How does accrual-based accounting affect exit valuation compared to cash-based reporting?
Accrual accounting gives buyers a much clearer picture of your true financial performance because it aligns revenue recognition with when services are delivered, not when cash is received. Cash-based reporting often inflates revenue and EBITDA in a way that buyers immediately adjust down during Quality of Earnings (QoE) reviews. Accrual-based financials allow buyers to evaluate margins, revenue stability, and EBITDA trends more accurately, giving them confidence to underwrite valuation. As Ed emphasizes repeatedly in The Entrepreneur’s Exit Playbook, founders who operate on GAAP accrual standards early enter M&A conversations with far stronger negotiating positions.
When should founders begin preparing their deferred revenue schedules before selling?
Founders should begin cleaning up deferred revenue schedules at least 18 to 24 months prior to a planned exit. Deferred revenue often requires historical restatements, reconciliations between contract start dates and revenue recognition, and full documentation that aligns with GAAP standards. Starting early allows time to fix any discrepancies before buyers ever see them. Attempting to “clean it up” during live diligence raises buyer concerns and can derail valuation, add deal structure complexity, or even cause deals to fall apart entirely.
How can deferred revenue issues impact working capital negotiations?
In most deals, deferred revenue is excluded from working capital true-up calculations because buyers inherit both the cash and the obligation to deliver services post-close. However, if deferred revenue is incorrectly classified or calculated, it can result in unintentional working capital shortfalls, leaving founders with less cash at closing. Buyers may also attempt to include deferred revenue in net working capital adjustments to reduce purchase price. Founders who clearly document deferred revenue classifications early can prevent these surprises and protect cash proceeds at closing.
What’s the biggest mistake founders make when handling deferred revenue before exit?
The biggest mistake is assuming deferred revenue and accrual issues can be fixed late in diligence — often under buyer pressure. Buyers expect these issues to be fully addressed well before the LOI stage. Once in diligence, unresolved deferred revenue discrepancies signal sloppiness, which damages trust and gives buyers the leverage to demand purchase price reductions, larger escrows, and longer earnouts. As Ed consistently teaches at Legacy Advisors, founders who control deferred revenue discipline long before they enter the market control the deal — financially and structurally.