How much cash flow does a business need to qualify for an SBA 7(a) acquisition loan?

Enough to cover the new debt 1.25 times over, on a straight acquisition. SBA sets the debt service coverage floor by transaction type in Appendix 15 of SOP 50 10 8.1.

Initial acquisition: 1.25:1. Business expansion: 1.15:1. Owner buyout: 1.25:1. ESOP and cooperative: 1.25:1.

The ratio must be satisfied using either the last fiscal year end or an average of the last two fiscal year ends, on a historical or adjusted basis depending on the transaction type. It is a test against what the business has actually done, not against what it might do once you own it.

Which earnings figure the lender uses

Not the one in the listing. SBA requires the lender's financial analysis to be based on the three most recent year-end financials using the highest level of reporting available, ranked in order: audited statements, reviewed statements, CPA-compiled statements, then corporate tax returns. The lender must also analyze the most recent interim statement alongside the comparable interim from the prior year, and must verify the applicant's corporate tax returns against the tax transcripts.

On deals at or above a $3 million business purchase price, a further rule applies: the lender must use the earnings figure from the required quality of earnings report in the debt service coverage determination. Where that report disallows add-backs the seller claimed, the coverage ratio is calculated on the lower number.

What this means in practice

Coverage is the constraint that most often resets a price. The purchase price sets the loan, the loan sets the annual debt service, and the verified earnings have to clear that payment by 25% on an initial acquisition. If the earnings that survive verification come in below the earnings in the broker's package, either the price moves, the buyer puts in more equity, or the deal does not fund.

SBA addresses that case directly in the equity rules: where the sale price exceeds the value supported by the business valuation and the quality of earnings report, additional funds may be brought in from limited equity sources, and those funds must be on full standby.

Two things follow for a buyer. Advertised seller's discretionary earnings is not the number the loan is sized against. And a replacement manager's salary matters, because if you will not be running the business day to day, the cost of the person who does belongs in the earnings the lender tests.

Considering a business purchase? BankableDeal can help review the earnings, add backs, and working capital behind the deal.