Most buyers hear “quality of earnings” and think it is extra due diligence paperwork. Something the lender asks for on bigger deals. Maybe optional on smaller ones.

It is not optional. And on SBA deals specifically, misunderstanding what a QofE actually does is one of the fastest ways to blow up a deal in the final 60 days. We have watched it happen enough times that the pattern is unmistakable: buyer gets comfortable with a number, orders the report late, the report comes back telling a different story, and suddenly the entire deal structure falls apart with the closing date two weeks out.

Here is what a quality of earnings report is, why SBA lenders care so much about it, and how to use it as a weapon rather than an obstacle.

What a Quality of Earnings Report Actually Is

A quality of earnings report is a financial analysis prepared by a third-party accounting firm that examines whether a business’s reported earnings are real, recurring, and sustainable.

It is not an audit. That distinction matters. An audit verifies that the books are accurate. A QofE goes further: it asks whether the profits a buyer is paying for will actually show up after the deal closes. Two businesses can have perfectly accurate books and wildly different earnings quality. One has $500K in repeatable, contractual revenue with diversified customers. The other has $500K that includes a one-time insurance settlement and a customer who already gave notice. The books are right in both cases. The QofE catches what the books do not tell you.

The report typically covers normalization of the seller’s add-backs (the adjustments that convert net income to SDE or EBITDA), one-time and non-recurring revenue or expense items, customer concentration risk, revenue recognition practices, working capital analysis, and cash flow quality and consistency.

On an SBA acquisition, the QofE serves as the foundation for two things: the lender’s credit memo and the buyer’s negotiating position. Both matter enormously.

When SBA Lenders Require a Quality of Earnings Report

Not every SBA deal requires a formal QofE. Whether one gets required depends primarily on deal size.

Most SBA lenders will require a quality of earnings report on acquisitions above $250K to $350K in SDE or above $1.5M to $2M in purchase price. Below those thresholds, a CPA-prepared financial analysis or detailed financial statement review may suffice. Above them, you are almost certainly getting a QofE requirement baked into the commitment letter.

Some lenders require them on all deals above $500K in purchase price regardless of cash flow. If your preferred lender has a strict QofE policy and you are buying a $750K business, budget for it.

The buyer orders the report, the buyer pays for it, and the report gets delivered to both the buyer and the lender. Cost ranges from $5,000 to $25,000 depending on business complexity and the accounting firm. On deals above $2M, expect to be in the $15,000 to $25,000 range.

What a QofE Can Do to Your Deal Valuation

This is where buyers get surprised.

A quality of earnings report does not just confirm the numbers. It frequently changes them. Say you are looking at a distribution company listed at $2.2M with the broker quoting $600K in SDE. You submit an LOI based on those numbers. Forty days later, the QofE comes back with adjusted SDE of $480K.

That $120K gap is not trivial. At 3.5x, it is a $420K difference in justified price. Your debt service model, your DSCR, your equity injection math, your working capital assumptions, everything shifts. And the lender is looking at those same adjusted numbers when deciding whether to fund the deal.

Common QofE adjustments we see on SBA deals:

  • Owner add-backs that do not pass scrutiny. A seller claiming $80K in personal vehicle expenses, $30K in travel, and $40K in family member salaries who will not be staying. A diligent QofE will accept some of these and push back on others.
  • One-time revenue lumped into baseline. A company that landed a $200K contract last year that is not recurring. If that is sitting in revenue but will not repeat, it should not be part of the normalized cash flow.
  • Accounts receivable concentration. One customer representing 40% of revenue changes the risk profile materially. The QofE will flag it. The lender will price it.
  • Undisclosed liabilities. Capital lease obligations, deferred revenue, accrued payroll. These are not always obvious in seller-provided financials.

When the QofE comes in lower than expected, you have three choices: renegotiate the price, walk away, or accept a thinner margin of safety. The first option is almost always the right move.

How the QofE Feeds SBA Underwriting

The lender’s underwriter does not just look at the QofE report and rubber stamp approval. They use it to build the debt service coverage model that determines whether the deal is fundable.

SBA underwriting formally requires a 1.25x DSCR minimum, but that number is misleading if you treat it as a target. It is the regulatory floor, not a reasonable operating standard. We target 2x DSCR on Regalis deals, with 1.5x as our hard floor. At 1.25x, a single bad month or one lost customer can push you below breakeven on debt service. That is not a margin of safety. That is a margin of hope.

Here is how the QofE connects to that number:

The QofE produces an adjusted EBITDA or SDE figure. The underwriter takes that figure, subtracts estimated taxes, an owner’s salary (if not already reflected), and capital expenditure requirements. What remains gets compared to the annual debt service on the SBA loan.

If the QofE-adjusted cash flow does not support the debt service at the requested loan amount, the lender has four options: require a higher equity injection, reduce the loan amount, require additional collateral, or decline the deal.

And here is something that catches buyers off guard: working capital requirements factor into this equation too. You need 2 to 6 months of operating expenses available post-close, and that capital has to come from somewhere. If your deal structure accounts for the purchase price and debt service but ignores the $50K to $150K in working capital you will need on day one, the underwriter will notice even if you did not. Some lenders build working capital into the loan itself. Others expect the buyer to fund it separately out of pocket. Either way, it affects how much total capital the deal actually requires and whether the numbers work.

A well-prepared QofE that validates strong, clean cash flow makes this process faster and cleaner. A QofE that raises red flags does not necessarily kill the deal, but it adds negotiating leverage on price and gives the lender reason to underwrite more conservatively.

How to Prepare Before the QofE Process Starts

If you wait until the QofE is ordered to think about the numbers, you are already behind.

The best buyers do a shadow QofE before submitting an LOI. You take the seller’s financials, go through every add-back line by line, stress-test the revenue for one-time items, and build a conservative SDE figure before you commit to a price. This does not require hiring an accounting firm at the LOI stage. It requires a rigorous internal review with someone who has done it before.

Steps to run a pre-LOI shadow QofE:

  1. Pull 3 years of P&Ls plus year-to-date financials. Request bank statements to cross-reference. (Side note: proof of cash matters enormously here. If the bank statements do not tie to the tax returns, stop and figure out why before going any further.)
  2. List every add-back the seller or broker is claiming. Categorize each as fully supportable, partially supportable, or questionable.
  3. Haircut the questionable add-backs. Be conservative. If it would not survive scrutiny from a CPA, cut it.
  4. Check year-over-year revenue trends. Flat or declining revenue with increasing EBITDA is a flag.
  5. Run the debt service model at your haircut SDE figure, not the seller’s headline number.
  6. If the deal still works at your conservative number, structure the LOI at that price.

This approach does two things. It eliminates surprises when the formal QofE comes back. And it gives you a defensible basis to renegotiate if the formal QofE comes in below the LOI price.

So that covers preparation. The harder part is what happens when the report actually lands.

Structuring Price Adjustments After a QofE Finding

The QofE finds something. It almost always does.

If the formal QofE reduces adjusted SDE by more than 10% from the LOI basis, you have grounds to reopen price. Most well-drafted LOIs include a provision that makes the final price contingent on due diligence findings, which explicitly covers QofE.

The cleanest approach: present the QofE-adjusted SDE to the seller, apply the same multiple used in the original LOI, and propose a revised price. If the seller originally represented $600K in SDE and the QofE supports $490K, the math is straightforward. At 3.5x, the price moves from $2.1M to $1.715M. Not a range. A number.

Sellers push back. That is normal. But the QofE report is third-party and objective. It is harder to argue with than a buyer’s assertion.

A few other structures that can bridge a QofE gap:

  • Earnout. A portion of the purchase price is contingent on the business hitting revenue or cash flow targets post-close. The seller gets full price if the earnings hold up.
  • Seller note adjustment. Instead of reducing the headline price, reduce the seller note principal or defer payments. On SBA deals specifically, the lender has to approve any creative structure around the seller note. A 10-year full standby, 0% interest seller note (which is the structure we achieve on 90%+ of our deals) is the cleanest option and preferred by SBA lenders.
  • Escrow holdback. A portion of proceeds sits in escrow for 12 to 24 months, released only if specific earnings benchmarks are met.

Meet on price, win on terms. That principle applies here as much as anywhere in deal structuring.

Quality of Earnings Report for SBA Loan: What Most Buyers Get Wrong

The most common mistake is treating the QofE as a checkbox rather than a tool. Buyers who order the report, get it back, and then hand it to the lender without reading it carefully are leaving real money on the table. A third party just told you exactly what the business is actually worth. Use it.

Second mistake: not building the QofE cost into your deal budget from day one. Between the QofE ($5K to $25K), environmental if applicable, the appraisal the SBA requires, legal fees, and the SBA guarantee fee (which runs approximately 3.5% on most loan amounts), your out-of-pocket transaction costs on a $2M deal can run $75K to $100K beyond the equity injection. And that is before working capital. Budget 2 to 6 months of operating expenses as post-close working capital on top of everything else. Buyers who plan for the purchase price and forget about operating cash on day one end up in trouble fast, even when the deal itself was solid.

Third mistake: ordering the QofE too late. Some buyers wait until they have full lender commitment before ordering it. The lender wants the QofE to finalize commitment. The QofE firm needs 3 to 6 weeks. This creates a logjam that pushes close dates out significantly. Order it immediately after your LOI is signed. Three to six weeks. Minimum.

Frequently Asked Questions

Is a quality of earnings report required for all SBA loans?

No. A formal QofE is typically required by SBA lenders on acquisitions above $1.5M to $2M in purchase price or where SDE exceeds $250K to $350K. Smaller deals may require a CPA-reviewed financial analysis instead. Lender policies vary, so confirm the requirement when selecting a lender, before you go under LOI.

Who orders and pays for the quality of earnings report on an SBA deal?

The buyer orders and pays for the QofE report. The accounting firm works for the buyer, but lenders treat it as an independent, objective analysis because the firm has no stake in the deal closing. Cost runs $5,000 to $25,000 depending on business size and complexity.

How long does a quality of earnings report take?

Most QofE engagements take 3 to 6 weeks from kickoff to final report. Complexity, size of the business, and how quickly the seller provides documents all affect timeline. Plan for this when setting a closing date in your LOI. A 30-day diligence period is usually not enough time to complete a QofE properly.

What happens if the QofE comes in lower than the LOI price?

You have grounds to renegotiate. Most LOIs include provisions allowing price adjustments based on due diligence findings. Present the QofE-adjusted numbers to the seller with the same multiple from the original LOI and propose a revised price. Earnouts, adjusted seller note terms, or escrow holdbacks can bridge smaller gaps when a straight price reduction meets resistance.

Can the SBA loan be denied because of a quality of earnings report?

Yes, indirectly. If the QofE significantly reduces adjusted cash flow, the resulting DSCR may fall below what the lender will approve. The SBA regulatory minimum is 1.25x, but we would never structure a deal that thin. Our standard is 2x with a 1.5x hard floor. If a QofE adjustment pushes you below 1.5x, the deal needs restructuring or it is not the right deal.

Thinking About Acquiring a Business?

Regalis Capital is a done-for-you acquisition advisory firm. We source deals, run the numbers before you commit, manage the QofE process alongside your CPA, and work directly with SBA lenders from LOI to close.

If you are serious about buying a business and want a team that has been through this process hundreds of times, start here.