ISSUE #001 | OCTOBER 11, 2026

$700,000 of earnings should be enough to finance this acquisition.

It is—until $75,000 disappears.

On October 1, new SBA 7(a) rules took effect for change-of-ownership transactions.

For an Initial Acquisition, the new acquisition-specific rules require historical debt-service coverage of at least 1.25×.

For qualifying Initial Acquisitions with a business purchase price of $3 million or more, the lender must also obtain an independent Quality of Earnings analysis.

Those sound like lending rules.

But underneath them is a question every buyer should understand:

How much of the earnings you're buying will actually support the debt you're taking on?

Let's run a deal.

Consider a hypothetical service business.

ASSUMPTION

Purchase price: $3,500,000
Closing costs: $100,000
Working capital: $150,000

Total project cost:

$3,750,000

Assume there's no real estate and all three uses are part of the project.

For an Initial Acquisition, the minimum equity injection is 10% of total project cost.

So our buyer needs:

$375,000

That leaves:

$3,375,000

to finance.

Now we get to the number that matters.

Assume the $3.375 million is financed over 10 years at an illustrative 10% interest rate.

That's an assumption—not a loan quote.

CALCULATION

Approximate annual debt service:

$535,210

At 1.25× coverage, the business needs approximately:

$669,013

of qualifying annual cash flow to support that debt.

Now suppose the seller presents:

$700,000 of adjusted earnings.

$700,000 ÷ $535,210 = 1.31×

The deal works.

Until we ask a harder question.

Adjusted earnings often contain add-backs.

Maybe there's a family member on payroll.

Vehicles.

Travel.

Legal expenses.

A one-time repair.

Owner-related expenses.

Some adjustments may be legitimate.

Others may not survive underwriting.

And because our hypothetical acquisition crosses the $3 million threshold, the lender must obtain an independent Quality of Earnings analysis.

So let's assume that process supports:

$625,000

instead of $700,000.

Only $75,000 disappeared.

Watch what happens.

CALCULATION

$625,000 ÷ $535,210 = 1.17×

The deal no longer clears 1.25×.

The asking price didn't change.

The buyer's offer didn't change.

The company didn't lose a customer.

But the financing broke.

That's the distinction worth remembering.

Buyers spend a lot of time talking about multiples.

“It's a 4× deal.”

“It's a 5× deal.”

“The seller wants too much.”

Those numbers matter.

But a multiple doesn't make the loan payment.

Cash flow does.

There are really three different questions:

What does the seller want?

That's price.

What is the business worth?

That's valuation.

What can the business support?

That's financeability.

Those numbers don't have to be the same.

Our hypothetical business may still be worth $3.5 million.

It may still be a good company.

It may even still be a good acquisition.

But the original structure no longer works.

Something has to change.

The purchase price could come down.

The buyer could contribute more equity and borrow less.

An adjustment might have better documentation than initially recognized.

The transaction structure could change.

Seller financing could play a role, subject to SBA requirements.

Or the business simply may not produce enough cash to support the price.

Those aren't the same problem.

A buyer needs to know which one they're dealing with.

Cash flow isn't the only place a deal can break.

Suppose the buyer agrees to pay:

$3,500,000

But the independent business valuation supports:

$3,200,000

That's a:

$300,000 gap.

A buyer shouldn't assume more acquisition debt will simply fill it.

That difference can mean additional equity, another compliant source of capital, a restructured transaction—or a lower price.

Now look at the deal we started with.

The buyer saw:

$3.5 million purchase price.

Then discovered:

Total project cost is $3.75 million.

Minimum equity is $375,000.

Proposed annual debt service is approximately $535,210.

The business needs approximately $669,013 of qualifying cash flow.

And $700,000 of advertised earnings becomes $625,000 after our hypothetical adjustment.

Suddenly:

“Is $3.5 million a fair price?”

isn't enough.

The better question is:

Can this business actually support the deal we're trying to put on it?

1. What earnings are actually defensible?

Not just the adjusted number in the listing.

I'd want to understand the material add-backs and the evidence supporting them.

2. What is the total project cost?

Purchase price isn't necessarily the whole check.

3. How much debt does the historical cash flow support?

I'd run that math before negotiating myself into a structure the company can't carry.

4. What happens if supported earnings come in 10%, 15%, or 20% lower?

A deal that only works if every adjustment survives doesn't leave much room for error.

5. What happens if the valuation comes in below my price?

Where does the difference come from?

I'd rather answer that before becoming emotionally and financially committed to closing.

The asking price is visible.

The multiple is easy to calculate.

Neither tells you whether the transaction works.

A buyer ultimately has to connect:

Price → earnings → debt → debt service → cash flow

If one link breaks, something has to change.

So before asking:

“What multiple am I paying?”

I'd ask:

“How much of these earnings will survive scrutiny—and how much debt can they support?”

Because agreeing on a price gets you a deal on paper.

Cash flow is what gets you to closing.

—

Know someone buying a business?

Forward them this issue.

SOURCES

SBA — SOP 50 10 8.1
SBA — Appendix 15: Change of Ownership

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