SBA-backed acquisitions are a fantastic way to buy a solid small business with modest equity. They also create a false sense of security. Lenders do their own checks, but those checks protect the bank, not you. If you rely on lender approval as your green light, you can still overpay, inherit brittle operations, and struggle with debt service once the first renewal season or slow quarter hits.
This guide is a practical, buyer-focused playbook for financial due diligence in SBA deals—what’s unique about SBA underwriting, why an independent QoE (or scoped financial review) matters, and exactly what to verify before you let the bank’s comfort become yours.
How SBA underwriting works (and what it doesn’t do)
SBA lenders focus on three things: ability to repay, adequate collateral/guarantees, and program compliance. They’ll test cash flow, sample financials, and review tax returns. That’s helpful, but their goal is a loan that performs under their assumptions—not an operating plan that performs under your reality.
Translation for buyers
- Bank diligence ≠ buyer diligence. The bank won’t price your replacement costs, validate every add-back, or map the working-capital rhythm you’ll live with after close.
- DSCR is modeled, not guaranteed. The lender’s model often assumes the seller’s Adjusted EBITDA and a “typical” working capital need. If those inputs are wrong, you carry the miss.
- Speed can mask fragility. SBA timelines push everyone to “keep moving.” That can turn unknowns into assumptions and assumptions into your problems.
Why a QoE or scoped financial review pays for itself
You don’t need a 100-page report. You do need an independent, document-backed view of earnings quality and working capital—the two inputs that make or break DSCR.
What a right-sized QoE/scoped review should give you:
- Validated Adjusted EBITDA. Owner comp, family roles, one-time items, and deferred spend reconciled to documents—with replacement-cost logic, not wishful thinking.
- Revenue quality. Contracted vs. at-will, churn and renewal insight, any timing or recognition issues.
- Working capital peg. TTM view of AR + Inventory – AP, adjusted for aged AR, dead inventory, and stretched AP, with a recommended peg, collar, and true-up.
- Debt-like items. Deferred revenue cost-to-fulfill, sales/use tax exposures, accrued liabilities that function like debt.
- Negotiation exhibits. Side-by-side of seller vs. validated EBITDA, plus peg schedules you can paste into your LOI or APA.
The fee is small compared to the price movement and structure improvements a clean analysis unlocks—and versus the pain of fixing mistakes after you own the business.
The unique risks in SBA deals (and how to tackle them)
1) Overstated add-backs
What it looks like: Full owner salary added back, “one-time” legal every year, and sales/marketing cuts during sale prep.
Why it’s worse in SBA: DSCR math is tight. A $100k EBITDA miss at 3.25× is a $325k pricing problem and a covenant problem.
How to verify:
- Price the replacement cost (GM, controller, dispatcher) rather than the “removal.”
- Pattern-check “one-time” costs across 3–5 years; recurring = run-rate.
- Normalize spend that must return on Day 1 to sustain revenue.
2) Weak working capital positions
What it looks like: AR with a long tail, slow-moving inventory, AP stretched to 60–90 days to dress up cash.
Why it’s worse in SBA: You have less wiggle room to inject cash if balances snap back.
How to verify:
- Build a TTM monthly view of AR/Inventory/AP; set a peg on the average, not a lucky month.
- Discount aged AR, mark down dead stock, and normalize stretched AP.
- Write the definition, peg method, collar, and true-up into the LOI.
3) Owner comp and shadow labor
What it looks like: “Excess” salary add-back that assumes you’ll work for free or below market, or family roles that “won’t continue” but still need coverage.
Why it’s worse in SBA: If you underprice labor, you’ll either burn out or miss DSCR when you hire.
How to verify:
- Map duties and hours. Quote market comp for the roles you’ll actually fill.
- Add payroll taxes and benefits to the model.
- Adjust EBITDA now; don’t pretend sweat equity will cover it later.
4) Cash vs. accrual mismatches
What it looks like: Billings shown as revenue, cash-basis P&Ls, or prepaid service plans running through revenue without matching delivery.
Why it’s worse in SBA: The bank may accept tax returns and a light tie-out. You need accrual earnings to operate and to forecast DSCR.
How to verify:
- Recast to accrual. Separate billings from recognized revenue.
- For deferred revenue, estimate cost-to-fulfill and treat only that slice as debt-like at close.
- Exclude deferred revenue from the working-capital peg.
5) Customer concentration and transfer risk
What it looks like: One account >25% of revenue, at-will terms, and the owner is the relationship.
Why it’s worse in SBA: One lost account can put DSCR underwater.
How to verify:
- Compute largest % and top-3 %, get contract terms, and identify relationship owners.
- Price with the multiple, protect with structure: seller note, holdback, or a simple earnout tied to gross profit from named accounts.
- Paper transition duties and introductions in the LOI.
6) Deferred revenue traps
What it looks like: Big deposits or prepayments near close.
Why it’s worse in SBA: You may inherit the obligation without fresh cash inflow.
How to verify:
- Get a deferred revenue rollforward; confirm recognition matches delivery.
- Handle DR outside the peg; treat cost-to-fulfill as debt-like where material.
- Add a small holdback if onboarding risk is real.
What to ask for (pre-LOI package)
You can catch most issues before you spend real money.
- Top-10 customers (24 months) with revenue, gross margin if available, contract terms, and renewal dates.
- Monthly P&Ls (24 months) on an accrual basis; if cash-basis, request a bridge or do a quick recast.
- AR aging and inventory listing with write-off history; AP detail for the last three months.
- Seller’s add-back schedule with short rationales.
- Deferred revenue rollforward (if applicable): opening, billings, recognized, ending.
If a seller refuses this basic package, that is your signal.
How to use diligence to protect DSCR (without killing goodwill)
Lead with exhibits, not opinions
Sit down with a side-by-side: seller Adjusted EBITDA vs. validated Adjusted EBITDA, with document references. Do the same for the working-capital peg. It’s easier for a seller (and a lender) to react to math than to feelings.
Solve bounded issues with bounded tools
- Add-back disputes: bridge the delta with a seller note rather than pretending EBITDA is higher.
- Concentration: use a named-account earnout or holdback tied to gross profit retention, not vague growth targets.
- Deferred revenue/onboarding risk: apply a small escrow tied to delivery milestones.
Keep lender alignment tight
Share your validated EBITDA, peg schedule, and any structure changes with the bank early. You’ll avoid last-minute underwriting surprises and keep closing on track.
A right-sized QoE scope for SBA deals (2–3 weeks)
If time and budget are tight, ask your provider to focus on:
- Earnings normalization: owner/family comp, one-times, reinstated spend, depreciation vs. maintenance capex.
- Revenue quality: recognition, concentration, churn/renewal proof.
- Working capital: TTM peg with adjustments, collar, true-up language.
- Debt-like items: deferred revenue cost-to-fulfill, sales tax, accrued liabilities.
Deliverables to request: a 1–2 page issues list in week one; final exhibits you can drop into the LOI/APA and your lender package.
Sample LOI language (steal this)
Adjusted EBITDA basis
“Purchase price is based on normalized, QoE-validated Adjusted EBITDA, reflecting market-rate replacement for seller/related-party roles, exclusion of non-recurring items not supported by documentation, and normalization of discretionary spend required to sustain revenue.”
Working capital mechanics
“Working capital = AR + Inventory – AP (per historical policy), measured on an accrual basis. Peg equals TTM average as of the month prior to closing with a ±$[collar] and 60-day post-close true-up. Deferred revenue excluded from peg.”
Deferred revenue / debt-like
“To the extent closing deferred revenue relates to undelivered obligations, parties agree to a cost-to-fulfill adjustment of [X]% of the related balance, treated as a debt-like item for closing cash purposes.”
Risk-sharing structure
“Consideration may include a seller note and/or a named-account earnout tied to gross profit retention for Customers [A–C] over [12–18] months.”
Common pitfalls (and how strong diligence avoids them)
- Overstated add-backs → overpay + DSCR squeeze.
Fix: Replacement-cost logic, multi-year pattern-check, document-backed schedule. - Weak working capital → cash drain at close.
Fix: TTM peg, collar, true-up, and cleaned inputs (aged AR, dead stock, stretched AP). - Owner comp issues → unrealistic operating plan.
Fix: Price your own time or the hires you’ll make; model full payroll burden. - Cash vs. accrual mismatches → phantom profits.
Fix: Recast to accrual, separate billings from recognition, treat DR correctly. - Concentration → lender nerves and fragile DSCR.
Fix: Multiple haircut + note/earnout/holdback; paper transition duties. - Late lender engagement → closing delays and retrades.
Fix: Share validated numbers and structures early; confirm subordination on notes.
A quick example to make the math real
Seller’s story: $900k Adjusted EBITDA on $5.5M revenue.
Your review finds:
- Owner comp add-back trimmed by $90k after pricing a GM.
- “One-time” legal of $35k appears 3 of last 4 years—removed.
- Marketing reinstate: +$40k to protect pipeline.
- AR aging shows $120k >90 days—50% haircut; inventory includes $80k obsolete; AP stretched by ~$100k vs. historical cadence.
Result: Validated EBITDA = $735k. At 3.25×, EV delta vs. seller’s number ≈ $536k.
Working capital peg: TTM average (scrubbed) = $620k with a ±$100k collar.
Structure: $300k of the delta shifts into a seller note, $150k into a named-account earnout on gross profit, balance in price. Lender model updated with validated EBITDA and peg. DSCR holds at >1.5× in your downside.
You didn’t “win” the deal. You bought what you can actually run—and protected your loan.
Buyer checklist
- Pre-LOI package: top-10 customers with terms, 24 months monthly P&Ls, AR aging, inventory report, AP detail, add-back schedule, deferred revenue rollforward.
- Normalize earnings: replacement-cost logic, one-time pattern check, reinstated spend, maintenance capex view.
- Set the peg: TTM AR/Inventory/AP with adjustments; document formula, collar, true-up.
- Handle DR properly: exclude from peg; cost-to-fulfill as debt-like if material.
- Align structure to risk: seller note, named-account earnout, targeted escrow.
- Keep lender close: share validated exhibits early; confirm note subordination and any covenants.
Closing thought
SBA approval means the bank is comfortable for the bank. Your job is to be comfortable as the operator. A tight, buyer-focused financial review—light or full QoE—translates stories into numbers you can underwrite, protects DSCR, and gives your lender clean exhibits that speed closing. Do that, and the SBA loan becomes what it should be: affordable leverage on earnings you can actually collect, not hope you might.
Contact us today or book a free consultation and learn how we can be a trusted partner on your next deal!
