Related-party rent is another area where reported earnings can be misleading. Consider a company operating from real estate owned personally by the seller. The business pays $4,000 per month, while market rent is $9,000. Reported earnings therefore benefit from a $60,000 annual expense advantage that may disappear after closing.

The opposite can happen too. A seller may intentionally charge the business above-market rent, depressing reported earnings. In either case, the historical expense does not necessarily represent the economics of the business under new ownership.

A Quality of Earnings analysis should ask: What is the current rent? Who owns the property? Will the buyer remain in the facility? What rent will the buyer actually pay after closing? What does the market support? The normalization should reflect a reasonable, arm’s-length occupancy cost.

Related-party transactions require special attention because they can make historical earnings look stronger—or weaker—than the business would perform on a market basis.