THE SBA JUST MADE FINANCIAL DILIGENCE MANDATORY.
Two weeks ago the SBA dropped a new version of the rulebook that governs how banks underwrite every 7(a) loan in the country. It's called SOP 50 10 8.1, it takes effect October 1, and it rewrites the rules for buying a business with SBA financing.
If you're buying a business, selling one, or advising on either side, this is the most important change to acquisition lending in years. I'll walk through what changed, what it means, and the one deadline that matters.
First, quick context for readers who don't live in this world. The SBA doesn't lend money. Banks do. The SBA guarantees most of the loan through a program called 7(a), which is how most small businesses in America change hands. The rulebook those banks underwrite against is the SOP. When the SBA rewrites the SOP, it changes the terms of every deal in the market without passing a law.
You can download the full document from the SBA here: SOP 50 10 8.1 →
THE HEADLINE IS DILIGENCE
Starting October 1, every acquisition with a business purchase price of $3 million or more needs a quality of earnings report before the bank funds. Not optional. Not the buyer's call. Written into the rulebook.
A quality of earnings report is the study that tests whether the profit the seller claims is profit that shows up in the bank account. It reconciles the tax returns to the books to the bank statements. It tests every "addback," the adjustments sellers make to dress up their earnings. The one-time expense that happens every year. The owner salary no replacement would accept. The personal truck sitting in the fixed assets.
A QoE is not an audit. No opinion letter, no assurance. It answers one question: is the profit real?
For years, nothing in the rules required anyone to test those numbers. Buyers who knew better ordered a QoE on their own. Buyers who didn't signed personal guarantees against earnings nobody verified. The SBA got tired of guaranteeing the difference.
HOW THE MANDATE WORKS
Five things matter.
The $3 million threshold is measured on the "business purchase price," which excludes owner-occupied real estate at appraised value. More on that in a minute, because there's a wrinkle.
The bank orders the report and it is prepared for the bank. You cannot substitute one you bought yourself. Whatever you spend on it counts toward your required 10% equity injection.
The bank must underwrite to the QoE number, not the seller's. If the report cuts the earnings, the price or the structure moves.
The coverage floor went up. For first-time buyers, profit must now cover the loan payment 1.25 times over, up from 1.15. And projections no longer count toward clearing it. Historical earnings only.
One favorable carve-out worth knowing: serial acquirers doing add-on acquisitions under the "Business Expansion" category keep the old 1.15x floor. The SBA built a separate lane for proven operators with a track record, and the coverage standard there is lighter. If you've closed before and you're buying again, that distinction matters to your lender.
Put the first four together and closing on the seller's addback story is over. The scrubbed number is the number. Sellers holding out for 2021 multiples are going to feel this.
Under $3 million? Nothing forces you. Get one anyway. You are signing a personal guarantee on a 10-year note against a stream of earnings. Verify the stream.
THE REAL ESTATE CHEAT CODE IS DEAD
Business acquisition loans run 10 years. Real estate runs 25. The old SOP had a cliff: push real estate past 51% of the deal and the ENTIRE loan stretched to 25 years. Goodwill, working capital, everything. Buyers engineered for it. Add the building. Push the appraisal. Clear the line.
Gone.
Under the old rule, the whole loan got 25 years. Under the new rule, only the real estate piece does. The business piece stays at 10. Every dollar earns its own term now. Split the notes, or blend one note on the weighted average of where the dollars go.
On a $4 million loan that is 55% real estate at 10.5%, the payment goes from about $37,800 a month to about $41,300. Up 9%. Stack the new coverage floor on top and the same cash flow carries about 15% less debt than it did in September.
Funeral homes, car washes, daycares, shops that own their buildings. Those deals feel it most.
THE LOOPHOLE
Here is the wrinkle in the threshold. The $3 million runs on the business purchase price, which excludes owner-occupied real estate at appraised value.
A $4 million deal with a $1.2 million building is a $2.8 million business. No mandated QoE.
Real estate lost its term power and its threshold weight in the same rewrite. A building-heavy deal can slide under the diligence line.
If you find yourself relieved that nobody has to verify the earnings you are about to buy, sit with that for a minute.
ONE ASIDE FOR THE TAX NERDS
The dead cliff also frees your purchase price allocation to be a pure tax decision again instead of a term play. Buildings depreciate over 39 years. Goodwill amortizes over 15. When the term incentive disappears, the allocation can follow the tax math instead of fighting it. That one deserves its own issue, and it's coming.
THE CLOCK
A correction from the last issue. I wrote that deals needed SBA approval by September 30 to stay under the old rules. That was wrong, and the real answer is harder, not easier.
The SBA tied the rule to the loan number, not the application date. The new SOP applies to any application that receives an SBA loan number on or after October 1. A deal submitted September 25 that doesn't get its number until October 2 falls under the new rules.
That means submission alone doesn't protect you. Processing time does. If your deal pencils under the old math and dies under the new, you need your lender to confirm, in writing, when the loan number will issue. Not "we submitted it." When the number prints.
The SBA is holding lender office hours starting this week. Your banker has no excuse not to know where your file sits.
Given all that, seek qualified counsel.
Full disclosure: I'm a partner at Bedrock, a quality of earnings firm built for these deals, the $1-30M range where the big firms don't want the work and the generalists can't do it well. If you're under contract or heading there, book a call with our CEO Will McCurdy and get ahead of the bank.
Book a Bedrock call →