Beginning October 1, 2026, certain business acquisitions financed through the U.S. Small Business Administration (SBA) will face a new financial due diligence requirement. Under the SBA’s updated Standard Operating Procedure (SOP) 50 10 8.1, lenders will generally be required to obtain an independent Quality of Earnings (QoE) report for certain 7(a) change-of-ownership transactions when the business purchase price is $3 million or more.
For business owners considering a sale and buyers planning an acquisition using SBA financing, understanding this new requirement early in the transaction process can help avoid surprises and provide more time to prepare the necessary financial information.
What is a Quality of Earnings report?
A QoE is an independent, third-party financial analysis that closely examines a business’s financial performance and the financial information supporting its reported or adjusted earnings. While financial statements can show how a business has performed historically, a QoE helps evaluate whether reported or adjusted earnings are supportable and sustainable.
A QoE may analyze information such as financial statements, general ledger activity, tax returns, bank activity, revenue records, payroll, accounts receivable, customer concentration, working capital, and other underlying financial records.
The analysis may also evaluate adjustments or “add-backs” used to calculate normalized earnings. For example, a seller may add back an expense that is characterized as nonrecurring. A QoE can examine whether the available financial records support that treatment and whether the expense is truly unlikely to continue under new ownership.
This distinction can be particularly important when a business’s purchase price is negotiated using a multiple of EBITDA (earnings before interest, taxes, depreciation, and amortization) or another earnings measure. If due diligence results in changes to normalized earnings, it can affect the financial terms of the transaction even if the valuation multiple itself does not change.
When is a Quality of Earnings report required?
The new mandatory QoE requirement generally applies to initial acquisitions and business expansions involving a business purchase price of $3 million or more. This threshold is based on the business purchase price, not simply the amount being financed through the SBA loan.
Buyer equity, seller financing, and other financing sources do not reduce the purchase price for purposes of determining whether the threshold has been met. The appraised value of owner-occupied real estate included in the transaction is excluded when determining the business purchase price.
It is important to note that the requirement does not apply to every type of ownership transaction. For example, owner buyouts and Employee Stock Ownership Plan (ESOP) or cooperative transactions are excluded from the mandatory QoE requirement described above.
Who is responsible for the SBA-required Quality of Earnings report?
Under the new requirement, the QoE must be performed by an independent, experienced financial professional for the benefit of the lender, with the buyer responsible for the cost. As a result, a QoE report previously commissioned by the buyer or seller may provide useful information during the transaction, but it does not automatically satisfy the lender’s requirement. However, buyers and sellers should not wait until the lender begins its process to consider earnings quality.
How is a Quality of Earnings report different from a business valuation?
Although the two are related, a QoE report does not replace a business valuation. A business valuation addresses what a business is worth, whereas a QoE analysis focuses on answering questions such as:
- What earnings are actually being generated by the business?
- How well are those earnings supported by the underlying financial information?
- How sustainable are these earnings?
Under the new SBA requirement, these analyses serve separate purposes, making it important for buyers and sellers to understand that completing a valuation does not eliminate the need for a QoE in situations where this new SBA requirement applies.
How should buyers and sellers prepare?
The new SBA requirement further reinforces the importance of financial readiness when buying or selling a business. With the October 1 effective date approaching, buyers and sellers considering an SBA-financed transaction should discuss the requirement with their lender and transaction advisors early in the process. Determining whether a QoE will be required and understanding where it fits into the transaction timeline can help account for the additional time and cost involved and reduce potential delays.
What should buyers consider?
Buyers should understand how a QoE report could affect an acquisition. If normalized earnings are lower than initially presented, the difference could impact debt-service coverage, financing, purchase price negotiations, required equity, and/or the overall transaction structure.
SOP 50 10 8.1 also places increased emphasis on historical debt-service coverage for certain acquisitions. For initial acquisitions, qualifying historical or adjusted earnings generally must demonstrate debt-service coverage of at least 1.25x. Because of this, well-supported historical earnings can be especially important in determining whether a proposed transaction satisfies SBA requirements.
Buyers may choose to conduct financial due diligence earlier in the process for their own purposes. However, a buyer-commissioned analysis should not be assumed to replace the independent QoE that the lender must obtain when the SBA requirement applies.
What should sellers consider?
For sellers, preparation should begin before the business goes to market. Financial records should be consistent, complete, and supportable. Depending on the business, this may include reviewing tax returns, financial statements, general ledgers, bank statements, payroll records, accounts receivable and payable, fixed asset records, debt schedules, customer revenue information, and documentation supporting proposed earnings adjustments.
Sellers should also identify potential issues that could draw additional attention during a QoE, such as personal expenses paid by the business, related-party transactions, unusual or nonrecurring expenses, inconsistent revenue recognition, unsupported add-backs, and discrepancies between tax returns and internal financial records. Addressing these matters early does not guarantee a particular QoE outcome, but it can help sellers respond more efficiently to due diligence requests and reduce the likelihood of unexpected issues affecting the transaction.
We are here to help
If you are a business owner or a buyer navigating the financial due diligence, Quality of Earnings considerations, and other financial aspects of a transaction, our Mergers and Acquisitions and Business Valuations teams are here to help. Please reach out to discuss how the new SBA requirements may affect your upcoming business acquisition or sale.
