SOP 50 10 8.1 and the Quality of Earnings requirement

1. The trigger

A lender-commissioned Quality of Earnings report is required on 7(a) Initial Acquisitions and Business Expansions where the business purchase price is $3,000,000 or more, net of owner-occupied real estate at appraised value.(source: SBA SOP 50 10 8.1, Appendix 15)^src

The test runs on the purchase price of the business. It is not the loan amount, and it is not total project cost: equity injection, seller financing and loan structure do not change whether a transaction is in scope. The only thing netted out is owner-occupied real estate, at appraised value.

2. Which transactions — and which are exempt

The requirement applies to Initial Acquisitions and Business Expansions. Owner Buyouts and ESOP or cooperative transactions are exempt.(source: SBA SOP 50 10 8.1, Appendix 15)^src

• Initial Acquisition — a buyer acquiring a business. In scope at $3M and above.
• Business Expansion — an existing borrower acquiring another business. In scope at $3M and above.
• Owner Buyout — a change of ownership among existing owners. Exempt from the QoE requirement.
• ESOP / cooperative — exempt.

3. Who commissions it

The report must be commissioned by the lender and may not be prepared by or for the borrower or the seller.(source: SBA SOP 50 10 8.1, Appendix 15)^src

This is the provision that changes the market. A report ordered by the seller to market the business, or by the buyer for its own diligence, does not satisfy the requirement however good it is. The engagement letter runs to the lender, the lender is the addressee, and the report exists for the lender's benefit. A provider that has a stake in the deal — including a broker affiliated with either side — should not be preparing it. Our own rule on that is on the independence page.

4. What it must reconcile

The report reconciles accountant-prepared statements, tax returns, internal financials, general ledger data and IRS transcript data into normalized earnings.(source: SBA SOP 50 10 8.1, Appendix 15)^src

The IRS transcript leg is the one most often missing from traditional lower-middle-market QoE work, and it is the most valuable: the transcript is what the IRS actually holds, and a seller cannot edit it. Any difference between the return in the file and the return on transcript is a finding in its own right, not a reconciling item.

5. The Cash Proof

A Cash Proof reconciles receipts and disbursements to bank statement data across the trailing twelve months and the two most recent fiscal years.(source: SBA SOP 50 10 8.1, Appendix 15)^src

Three windows, each reconciled separately:

• the trailing twelve months;
• the most recent fiscal year; and
• the prior fiscal year.

In practice this means classifying deposits — customer receipts, card settlements, loan draws, owner contributions, transfers between related accounts — so that only revenue is compared with revenue. Loan proceeds and owner contributions counted as sales are the most common way reported revenue overstates the business.

6. Add-backs the SOP names

Every add-back is documented, including non-recurring items, owner compensation against market, related-party transactions, deferred maintenance, and cash-versus-accrual differences.(source: SBA SOP 50 10 8.1, Appendix 15)^src

• Non-recurring items — and the evidence that they really do not recur. An expense that appears in all three years is not one-time.
• Owner compensation against market — the adjustment is the difference between what the owner is paid and a market replacement salary, in either direction. Adding back the owner's entire salary is not normalization.
• Related-party transactions — rent paid to an owner-controlled entity, payments to affiliates, family payroll. Adjusted to market, with the benchmark shown.
• Deferred maintenance — capital the seller did not spend and the buyer will have to. This one reduces earnings, which is why a schedule of only positive add-backs is incomplete on its face.
• Cash-versus-accrual differences — on a cash-basis business carrying receivables, payables or work in progress, the bridge to accrual earnings can move the figure more than every discretionary add-back combined.

7. The coverage floor, and no projections

Adjusted earnings feed the lender's debt-service coverage at a 1.25x floor for acquisitions and owner buyouts and 1.15x for expansions, and projections may not be used to meet it.(source: SBA SOP 50 10 8.1)^src

This is the credit consequence. The QoE's adjusted earnings are not an exhibit; they are the input to the coverage test. Earnings are carried through maintenance capital expenditure and cash taxes to cash available for debt service, then divided by annual debt service on the proposed structure.

A related point lenders already know but borrowers often do not: total debt is limited by the appraised value of the business, and The maximum 7(a) loan amount is $5,000,000.(source: SBA 7(a) loan program)^src On a file with healthy coverage, the binding constraint is frequently value — which is also driven by normalized earnings.

8. The changes that reinforce it

Appendix 15 does not stand alone. Several elements of the loan structure interact with the QoE's output:

• Equity injection of at least 10% of total project cost, with a seller note counting toward at most half of it — and only on full standby for the full term.
• Seller notes not on full standby are included in debt service.
• Amortization of the business portion over no more than ten years.
• Debt capped at appraised value, so a lower normalized earnings figure can shrink the loan even when coverage clears.

Confirm each against the current SOP text for your file; the SOP, not this summary, governs.

9. How a report maps to the requirement

Our lender report is organized in Appendix 15's order. The crosswalk below is rendered into every lender report.

Frequently asked questions

Primary sources

• SBA — SOP 50 10: Lender and Development Company Loan Programs
• SBA — 7(a) loans