QoE engagements have steadily moved downstream as buyers, lenders, and advisors seek greater assurance that the earnings presented by a seller are not only historically accurate, but also recurring and sustainable. Beginning October 1, 2026, QoEs will take on an even more significant role in certain transactions financed through the U.S. SBA. In this article, the author discusses the new SOP.
Quality of Earnings (QoE) analyses have become an increasingly important component of financial due diligence in mergers and acquisitions. Historically associated more frequently with private equity and larger middle-market transactions, QoE engagements have steadily moved downstream as buyers, lenders, and advisors seek greater assurance that the earnings presented by a seller are not only historically accurate, but also recurring and sustainable.
Beginning October 1, 2026, QoE will take on an even more significant role in certain transactions financed through the U.S. Small Business Administration (SBA). Under SBA SOP 50 10 8.1, Lender and Development Company Loan Programs, lenders will be required to obtain an independent QoE report for certain 7(a) change-of-ownership transactions with a business purchase price of $3 million or more.
The new requirement reflects an important distinction that valuation professionals have long recognized: the value of a business and the quality of the earnings supporting that value is related, but they are not the same question.
What Does the New SBA Requirement Provide?
SOP 50 10 8.1 becomes effective October 1, 2026, and establishes additional financial due diligence requirements for certain SBA 7(a) change-of-ownership transactions. The mandatory QoE requirement generally applies to two transaction classifications: initial acquisitions and business expansions where the business purchase price is $3 million or more.
Importantly, the threshold is based on the business purchase price before consideration of buyer equity, seller debt, or other financing sources (i.e., not considering post-sale synergistic value-additions). Furthermore, the appraised value of owner-occupied real estate included in the transaction is excluded in determining the business purchase price for purposes of the threshold.
The requirement does not apply in the same manner to every change-of-ownership transaction. Owner buyouts and ESOP/cooperative transactions are excluded from this mandatory QoE requirement. Another important distinction is who engages the QoE provider.
The SBA-required QoE must be performed by an independent, experienced financial professional and conducted for the benefit of the lender (with the cost thereof assumed by the buyer). It may not be prepared by or for the borrower or seller. Consequently, a QoE previously commissioned by a buyer or seller may provide valuable transaction intelligence, but it does not automatically satisfy the lender’s obligation under the new SOP.
QoE Does Not Replace the Need for a Valuation
Perhaps the most important aspect of the new SBA requirement is that the QoE does not replace the business valuation. The two analyses address different questions.
A business valuation asks: What is the business worth?
A QoE analysis asks: What earnings are being generated by the business, how reliable are those earnings, and are they sustainable?
A valuation professional may normalize historical financial statements when determining value. This can include adjusting owner compensation, eliminating nonrecurring expenses, considering related-party transactions, and identifying other discretionary or unusual items. A QoE goes further into the underlying financial information.
Depending upon the scope and circumstances, the analysis may examine the relationship among the company’s internal financial statements, general ledger, tax returns, bank activity, revenue records, payroll, accounts receivable, customer concentration, working capital and other financial information.
In other words, a valuation may utilize normalized earnings to develop an indication of value, while the QoE seeks additional evidence supporting whether those earnings are, in fact, supportable. Importantly, the QoE will denote how much debt the business can support (see below as sourced directly from the SBA “Lender and Development Company Loan Programs with Technical Updates”[1]):
What is the Purchase Price Truly Comprised Of?
Purchase prices in privately held business transactions are frequently negotiated as a multiple of EBITDA or another measure of cash flow. The apparent simplicity of that calculation can obscure an important issue.
Consider a business marketed at $4 million based upon $800,000 of adjusted EBITDA and a 5.0x multiple.
If due diligence determines that $150,000 of the seller’s proposed adjustments are unsupported, nonrecurring in the wrong direction, or otherwise not sustainable, normalized EBITDA may instead be $650,000. At the same 5.0x multiple, that difference represents $750,000 of the value. The multiple did not change, the earnings did. That is precisely why the quality of the underlying earnings can be as important as the multiple ultimately applied to them.
Add-backs are an obvious area of scrutiny. Sellers understandably want to identify expenses that will not continue under new ownership. Buyers, lenders, and valuation professionals must determine whether those adjustments are reasonable. An owner’s personal automobile expense may legitimately disappear after closing. A purported “one-time” marketing expenditure that has occurred during each of the last three years presents a different issue.
Similarly, replacing an owner who performs significant operational functions may require a market-rate replacement salary. Eliminating the owner’s entire compensation without recognizing the economic cost of replacing those services can materially overstate sustainable earnings.
Following the Cash
The SBA’s new requirements place particular importance on substantiating the financial information underlying the transaction. A QoE is not simply a recalculation of EBITDA from the seller’s P&L.
Among the significant elements of the SBA-required analysis is a cash proof, which provides an independent reconstruction of cash receipts and disbursements, and reconciles bank activity to reported financial information and tax returns over specified historical periods. This type of analysis can identify issues that might not be apparent from reviewing year-end financial statements alone.
For example, internal financial statements may report $5 million of revenue, while bank deposits, merchant processing records, tax returns, and other available evidence do not readily support that amount. The difference does not automatically establish an error; timing, transfers, financing activity, accounting method, and other reconciling items may explain it. However, the discrepancy warrants investigation.
The same principle applies to expenses. A QoE may identify personal expenses running through the business, nonrecurring costs, related-party payments, unusual accounting entries, changes in expense classification, or expenditures necessary to maintain current operations that have been characterized as discretionary.
The objective is not simply to find adjustments that increase or decrease EBITDA, it is to understand the economic earnings of the business and relay them accordingly to the end user of the report.
Historical Earnings Become Even More Important
The QoE requirement should also be viewed in conjunction with SBA’s increased emphasis on historical debt-service coverage in certain acquisition transactions.
For initial acquisitions, the new SBA SOP generally requires debt-service coverage of at least 1.25x based upon qualifying historical or adjusted earnings rather than allowing post-closing projections to cure inadequate historical coverage. That makes the reliability of normalized historical earnings particularly important.
Suppose a transaction initially appears to generate $500,000 of adjusted EBITDA against $400,000 of applicable annual debt service.
That produces exactly: $500,000 ÷ $400,000 = 1.25x
Now assume the QoE concludes that $75,000 of proposed adjustments cannot be supported.
Adjusted EBITDA falls to $425,000, and coverage falls to approximately: $425,000 ÷ $400,000 = 1.06x
The difference is no longer merely a disagreement over an adjustment; it can directly affect financing, purchase price, equity requirements, deal structure, or whether the transaction can proceed as contemplated.
Buyers and Sellers Should Not Wait for the Lender
The fact that the SBA-required QoE must be performed for the benefit of the lender does not mean buyers and sellers should wait until the lender underwriting process is initiated to evaluate earnings quality.
A seller preparing for a transaction can benefit from identifying potential financial reporting issues before the company goes to market. Discrepancies between tax returns and internal financial statements, undocumented add-backs, inconsistent revenue recognition, personal expenses, related-party transactions, inadequate working-capital records, and poorly supported balance-sheet accounts are generally easier to address before a buyer or lender discovers them.
Likewise, a buyer may elect to obtain pre-transaction financial due diligence for its own purposes. Although a solely buyer-commissioned report would not substitute for the lender-commissioned QoE required under the SBA SOP, it can provide important information before the buyer commits substantial time and capital to the transaction.
The distinction is important: Transaction readiness and buyer due diligence can occur before SBA underwriting. The SBA-mandated QoE, when applicable, is independently conducted for the lender.
Preparing for the New Environment
Businesses contemplating a sale should increasingly view financial readiness as part of transaction readiness. At a minimum, sellers should be prepared to produce financial information that can be reconciled across multiple sources. Depending upon the business, this may include tax returns, detailed profit-and-loss statements, balance sheets, general ledgers, bank statements, payroll records, accounts receivable and payable detail, fixed-asset records, customer revenue information, debt schedules, and supporting documentation for proposed normalization adjustments.
More importantly, the records should tell a consistent story. A sophisticated buyer, lender, valuation professional, or QoE service provider will not necessarily accept an adjustment simply because it appears on a broker’s recast financial statement. The underlying question will be: Can the adjustment be supported?
The Broader Implications
SBA SOP 50 10 8.1 represents more than an additional report requirement for certain $3 million-plus acquisitions. It reflects the continuing movement toward more rigorous financial due diligence in privately held business transactions (and reflects the need for such scrutiny as well).
For valuation professionals, transaction advisors, lenders, buyers, and sellers, the message is significant:
- A purchase price may be negotiated based upon earnings
- A valuation may be developed based upon earnings
- Debt service may be supported by earnings
With the common denominator as the dependence upon the quality, accuracy, and sustainability of those earnings.
Effective October 1, 2026, the SBA will formally require that question to receive additional independent attention in certain larger 7(a) change-of-ownership transactions. For sellers, preparation before going to market can reduce surprises. For buyers, financial due diligence can help distinguish reported earnings from sustainable economic performance. For lenders, an independent QoE provides another level of support for assessing the financial capacity underlying the transaction. And for valuation and financial professionals, the change reinforces a fundamental principle: The number at the bottom of the income statement is only the beginning of the analysis.
[1] https://legacy.sba.gov/document/information-notice-5000-880695-issuance-sop-50-10-81
Trisch Garthoeffner, ABV, CVA, MAFF, EA, MAcc, has 20+ years of experience in providing business valuation, financial forensic, and merger and acquisition consulting services. In 2020, she was elected to the NACVA Standards Board; in 2021, voted vice-chair; in 2022, voted chair; and is a current Executive Advisory Board advisor for the NACVA Standards Board. She is a past Florida state chapter president for NACVA, a current member of the NACVA exam task force, a board member and quarterly author for the QuickRead valuation periodical, a past treasurer of the Florida Academy of Collaborative Professionals, and a past vice-president of the Southwest Florida Chapter of Collaborative Professionals and current member. In 2024, Ms. Garthoeffner was nominated as a member of Business Valuation Resources (BVR) Leadership Council. On March 06, 2025, she will be in Washington DC with other NACVA representatives[1] to testify regarding NACVA’s collective input regarding the Treasury Department’s proposed rule – Regulations Governing Practice Before the Internal Revenue Service. In her spare time, she enjoys spending time with her daughter, exercising, antiquing, and fostering animals.
Ms. Garthoeffner can be contacted at (239) 919-3092 or by e-mail to trisch@anchorbvfs.com.
[1] T.J. Liles-Tims and Dalton Hopper
