How a Quality of Earnings Report Strengthens SBA 7(a) Business Acquisitions

Why This Matters

When acquiring a business using an SBA 7(a) loan, it’s easy to focus on surface-level financials and seller-reported earnings. However, relying solely on tax returns or management-prepared income statements can lead to costly surprises. That’s where a Quality of Earnings (QoE) analysis plays a critical role.

A thorough QoE doesn’t just verify numbers—it provides a deeper understanding of the business’s true earning power. It ensures your acquisition is sound and your SBA-backed investment is based on sustainable cash flow, not assumptions.

Understanding SBA 7(a) Loans in Business Acquisitions

SBA 7(a) loans are one of the most accessible and flexible financing tools for small business buyers. They support a wide range of use cases, including acquisitions, real estate, working capital, and equipment purchases.

Loan amounts go up to $5 million with terms as long as 10 years for most business acquisitions. Borrowers typically benefit from low equity injection requirements—usually at least 10%, with some lenders requiring more based on deal risk.

Another major benefit is the SBA guarantee, which reduces lender risk and enables financing for deals that may not qualify under conventional lending standards. However, this flexibility doesn't replace the need for serious diligence.

For deals involving goodwill above $250,000, SBA requires a formal third-party valuation performed by a qualified source (e.g., Certified Business Appraiser or Accredited Senior Appraiser) and in line with SOP 50 10 8 guidelines. Smart buyers go a step further by commissioning a Quality of Earnings report to ensure cash flow supports the valuation.

What Is a Quality of Earnings (QoE) Analysis—and Why It Matters

A QoE analysis investigates the sustainability and accuracy of earnings by adjusting for anomalies, non-recurring items, and inconsistencies. Unlike an audit, a QoE focuses on true operational cash flow—not GAAP compliance.

Key questions it answers:

• Are the earnings consistent and repeatable?
• Are one-time events inflating EBITDA?
• Are adjustments reasonable and defensible?

For SBA-backed acquisitions, this is critical. Debt service must be supported by actual cash flow, not inflated earnings. A QoE ensures the numbers reflect reality and gives buyers a defensible foundation for structuring offers.

How QoE Enhances SBA 7(a)-Funded Deals

A QoE report can:

• Support more accurate valuations—especially when goodwill is high.
• Uncover risks the seller may not disclose or even be aware of.
• Reinforce confidence with lenders, making underwriting faster and smoother.

Unlike standard valuations based on historical metrics, QoE dives into the business model’s mechanics: customer mix, revenue concentration, margin sustainability, working capital cycles, and cost structures.

It also flags red flags like:

• Recurring revenue misclassification
• Understated payroll due to owner roles
• Improper add-backs or expense treatments

Some SBA lenders now require or recommend a QoE on complex or mid-sized transactions. Submitting one proactively shows you're a serious buyer—often accelerating credit decisions.

A Realistic Example of QoE in Action

One client approached us while acquiring a paving company. Revenue was project-based, and books were kept on a cash basis. This distorted profitability.

We restated the financials on an accrual basis and uncovered a significantly lower true EBITDA than what had been presented. Our client walked away from the deal—avoiding what would’ve been a financially unstable acquisition.

In another case, we were hired during an acquisition of an electrical contracting business. The seller’s proposed working capital transfer was under six figures—well below what the business needed.

Our QoE showed that over seven figures were required post-close due to a long cash conversion cycle. The buyer renegotiated, saving over $1 million—and months later told us it was the best decision they made.

Best Practices for Integrating QoE into SBA 7(a) Deals

• Commission the QoE early—after LOI but before loan approval or final price negotiations.
• Communicate with your lender—they may incorporate the findings directly into underwriting.
• Use it for your team, not just lenders—share findings with legal and tax advisors to guide terms and structure.

Also, note that SBA generally prefers asset purchases over stock deals, as they offer clearer tax treatment and lower risk. Stock deals may still qualify, but they must be justified and fully documented per SBA policy.

Final Thoughts

An SBA 7(a) loan is a powerful tool for business acquisition—but it comes with expectations. Your deal must be supported by sustainable cash flow, not seller optimism.

A Quality of Earnings analysis uncovers the financial truth behind the business. It helps you:

• Structure smarter deals
• Reduce surprises
• Gain lender confidence

SBA 7(a) loan proceeds can be used to cover the cost of a QoE report and other eligible deal expenses. However, funds cannot be used for speculative investments, passive income, or unqualified debt refinancing per SBA guidelines.

If you’re financing your acquisition with an SBA 7(a) loan, make a QoE part of your process. The insights may save you time, money, and post-close regret.

Need help evaluating a business or preparing for your SBA lender?

Connect with Midwest CPA for in-depth Quality of Earnings analysis and financial diligence, and partner with Pioneer Capital Advisory to structure a winning SBA 7(a) deal from start to finish.

Together, we’ll help you close with confidence.

Reach out at chris@midwest.cpa, visit midwest.cpa, or visit Chris's LinkedIn and learn more about financing strategy. For our direct contact go to pioneercapitaladvisory.com.

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