By Alex Fritz, CPA, Director at Blue & Co., and President at One 2800 Capital Advisors, and Harsh Desai, Totl Manager

For borrowers, lenders, and advisors involved in SBA-backed lending to support business acquisitions, Quality of Earnings (“QoE”) analysis is becoming central to transaction diligence.

The SBA’s recent QoE requirement, effective October 1, 2026, is designed to bring greater certainty and credibility to SBA lending efforts and ensure that financing decisions for certain operating-business acquisitions rest on verified, sustainable cash flow. Not merely on seller-prepared financial statements, broker marketing materials, or unsubstantiated EBITDA add-backs.

For SOP-required transactions, the focus is clear: Can the subject business reliably generate enough normalized operating cash flow to support its debt obligations on a post-transaction basis to support the SBA lending efforts?

When is a QoE Report Required?

A QoE report is required for certain SBA 7(a) transactions involving:

• An initial acquisition of an existing business; or
• A business expansion through acquisition; and
• A business purchase price of $3 million or more.

The threshold applies to the operating business’s purchase price. The purchase price is evaluated on the gross transaction price, before reducing the value for buyer equity, seller carryback financing, or other debt sources that may be considered part of the contemplated transaction.

In other words, transaction structure alone does not eliminate the requirement. Under the terms of the proposed SOP, a borrower’s down payment or seller note does not change whether the underlying business purchase price triggers the $3 million threshold.

Where an acquisition includes owner-occupied commercial real estate, the appraised real-estate value is excluded when determining the business purchase price. This distinction can be important in transactions that combine real estate with goodwill, equipment, inventory, and any other operating assets.

Transactions Excluded From the Requirement

The QoE mandate does not apply to:

• Owner or partner buyouts;
• ESOP transactions; or
• Cooperative transactions.

The current SBA QoE requirement applies to qualifying 7(a) change-of-ownership transactions and is not currently required under the SBA 504 program, which is principally intended to finance fixed assets such as owner-occupied real estate, construction, and major equipment.

That said, the absence of an SBA QoE mandate does not eliminate the need for thorough underwriting. Lenders and Certified Development Companies may still require detailed financial diligence based on their own credit policies and the risk profile of a particular transaction.

What Does a QoE Actually Examine?

A QoE is more than an evaluation of reported revenue and Earnings Before Interest, Taxes, Depreciation, and Amortization (“EBITDA”). It is an independent evaluation of the reliability, sustainability, and accuracy of a business’s historical and projected revenues and earnings, which provides comfort to lenders assessing the ongoing operations to support lending efforts.

The analysis should be performed independently for the lender’s benefit and should reconcile key financial records, including:

• Internal company financial statements;
• Accountant-prepared financial statements;
• Federal business tax returns;
• IRS tax transcript information; and
• Bank account activity.

A key component of the QoE is the proof of cash analysis. The report should substantiate cash activity for the trailing 12-months and the prior two fiscal years, helping identify inconsistencies between reported revenue, bank deposits, expenses, and other financial information.

This gives the lender greater confidence that the cash flow used in underwriting reflects the economics of the business, not simply its presentation.

The Critical Role of Normalized Earnings

In many middle-market and lower-middle-market transactions, normalized EBITDA includes adjustments for owner compensation, discretionary expenses, nonrecurring costs, related-party transactions, or other claimed add-backs as prepared and presented by company management/ownership/advisors.

A QoE examines whether those adjustments are reasonable and adequately supported and provides further comfort in an institution’s lending efforts.

Key diligence areas may include (but not limited to):

• Whether owner compensation has been normalized to a market-based replacement cost;
• Whether related-party rent, management fees, or other affiliated transactions reflect arm’s-length terms;
• Whether revenue and expense recognition is consistent and properly matched;
• Whether unusual or one-time items are truly nonrecurring; and
• Whether claimed discretionary add-backs or normalization adjustments have adequate documentary support.

This process may materially change the cash flow available to service debt.

Beyond the Numbers: Sustainability Risk Matters

The QoE process also addresses qualitative risks that can affect post-closing performance and debt-service capacity. These may include:

• Customer and supplier concentration;
• Revenue-cycle trends;
• Contract expirations or customer attrition;
• Gross-margin consistency;
• Regulatory exposure;
• Competitive pressure and technology obsolescence;
• Labor availability and workforce conditions;
• Dependence on a key owner or employee;
• Lease, license, and permit status;
• Economic sensitivity; and
• Management team’s industry experience, qualifications, and transition plan.

These factors are especially important because a business can show positive historical earnings while still facing significant risks to continue producing future cash flow.

Why This Matters to Deal Participants

For lenders, the QoE provides a foundation for evaluating a company’s ability to service the debt associated with the prospective transaction and a benchmark for debt-service coverage. For borrowers, it offers a cleaner snapshot of the actual earnings/cash flow they are acquiring. For sellers, it reinforces the importance of maintaining clean financial records and being prepared to support all seller-proposed EBITDA adjustments. For lenders, the QoE analysis provides additional insight that enables lenders to evaluate the merits of underwriting efforts in support of the SBA lending effort.

Ultimately, the relevant operating cash flow is not simply the seller’s stated EBITDA. It is the normalized cash flow established through a disciplined QoE process.

For certain SBA 7(a) acquisitions, parties that address QoE diligence early, rather than treating it as a late-stage underwriting condition, will be better positioned to identify issues, support valuation, structure financing appropriately, and move toward closing with fewer surprises.

Why Blue & Co. for Quality of Earnings Diligence?

Blue & Co. brings more than 50 years of accounting and advisory experience to businesses navigating important transactions. We have been a trusted partner to many national, large- to mid-sized financial institutions, providing SBA 7(a) business valuation and related consulting services for the past 20 years. Additionally, Blue & Co. has built a premier team with the expertise to provide Quality of Earnings support to our clients across a variety of transactional support areas.

Naturally, our team is prepared to bring this service and expertise to our financial institution relationships, built through years of great service supporting SBA lending efforts. Our Quality of Earnings work goes beyond reported EBITDA by testing the durability of earnings, evaluating support for adjustments, analyzing cash-flow drivers, and identifying financial and operational issues that may affect valuation, financing, and post-closing performance.

Our team combines transaction-focused financial analysis with industry-specific insight across closely held businesses, manufacturing and distribution, healthcare, professional services, construction, real estate, hospitality, and other sectors. Whether the engagement supports a buyer, seller, lender, or advisor, we provide a clear view of normalized earnings and the risks behind them.

Prepare for Enhanced SBA Acquisition Diligence

For qualifying SBA 7(a) acquisitions, the Quality of Earnings analysis can directly influence financing structure, valuation support, and the path to closing. Contact your Blue & Co. advisor to discuss how Quality of Earnings diligence may apply to your transaction and how early preparation can help support a more informed process.