For ambitious founders in their 20s and 30s eyeing their next acquisition, few things are as frustrating as investing in thorough due diligence, only to find a crucial piece of that work ignored. Heather Endresen, a sharp voice in small business acquisitions, points out a significant disconnect: many SBA lenders' credit departments simply don't care about your expensive Quality of Earnings (QoE) report.

Key Takeaways

  • Buyers routinely invest in detailed Quality of Earnings (QoE) reports to understand a target business's true financial health.
  • Despite their value, many SBA lenders overlook QoE reports because the SBA mandates they base cash flow assessments solely on tax returns.
  • This regulatory gap creates friction, as lenders miss vital insights from QoE, like accounting clean-up details and working capital analysis.
  • Forward-thinking brokers, like one Mills Snell mentioned, now require sellers to pay for a sell-side QoE to pre-empt issues and speed up deals.
  • Understanding the SBA Lender's Stance on Quality of Earnings (QoE) framework is key to navigating your next acquisition finance.

The SBA Lender's Stance on Quality of Earnings (QoE)

This framework describes the current reality of how SBA lenders process and view Quality of Earnings reports, often overlooking their full value due to regulatory minimums, creating friction in the diligence process for buyers who invest in these reports.

  • SBA Requirement for Lenders: The SBA only requires lenders to look at tax returns. They require that the cash flow to be based on tax returns.
  • Buyer's Autonomy in QoE: The SBA not forcing a QoE allows the buyer to decide who they want to use, pick the vendor, and pick the scope of work, which is seen as a good thing.
  • Lender's Common Behavior: Because the SBA doesn't require the quality of earnings and they require the tax returns, there's a lot of SBA banks where the credit people will not look at the QOV (Quality of Earnings).
  • Lender's Perception of QoE: Many banks have an internal attitude that the QOV is just to verify add-backs and they don't need to see it, despite it containing great findings and clean-up of accounting errors, and information about working capital.

When This Works (and When It Doesn't)

This framework accurately describes the current landscape of SBA lending for small business acquisitions. It works by clarifying why buyers often feel frustrated when their detailed QoE reports, which can cost tens of thousands, seem to get a cursory glance (or none at all) from SBA lenders. This setup works for lenders who simply want to tick the box on SBA requirements, but it utterly fails ambitious buyers who seek a deep, nuanced understanding of a business's finances.

Where it doesn't work is in fostering efficient deal flow or truly mitigating risk for buyers. As Endresen put it, “Because the SBA doesn't require the quality of earnings and they require the tax returns, there's a lot of SBA banks where the credit people will not look at the QOV.” This means the crucial insights a QoE provides—like detailed accounting clean-up, identification of one-time expenses, and deep working capital analysis—are often ignored by the very institutions providing the capital. It slows down deals and adds unnecessary stress for buyers.