Most buyers reviewing an acquisition focus on the adjusted EBITDA or seller's discretionary earnings (SDE) presented in the broker's Confidential Information Memorandum (CIM).
The problem is that the lender may arrive at a very different number.
A business advertised with $900,000 in SDE could end up with just $600,000–$700,000 in earnings recognized during underwriting.
That doesn't necessarily mean the broker's calculations are wrong. It means the lender needs documentation to support each adjustment before including it in the cash flow analysis.
This matters because lenders base their financing decisions on the earnings they can verify, not the figures presented in the CIM.
As a general rule, every dollar removed from recognized earnings can reduce borrowing capacity by approximately $5–$6.
For buyers, discovering that difference several weeks after signing an LOI, and potentially $20,000 into legal and due diligence expenses, can create serious problems.
How Lenders Recalculate Seller's Discretionary Earnings
When reviewing an acquisition, underwriters typically start with three years of filed tax returns, an interim profit and loss statement, and the trailing 12 months of bank statements.
The CIM provides useful information, but the lender needs to verify the reported earnings against the business's financial records.
Starting with reported net income, the lender generally adds back interest, depreciation, amortization, and the seller's compensation and benefits.
These are the standard components of SDE.
From there, the lender reviews any additional expenses the seller or broker has identified as potential add-backs.
Those adjustments generally fall into three categories:
- Accepted add-backs
- Add-backs requiring further documentation
- Rejected add-backs
Under SBA SOP 50 10 8.1, applicable to loans receiving an SBA number on or after October 1, 2026, initial acquisitions with a business purchase price of $3 million or more also require a lender-commissioned quality of earnings (QoE) report in addition to the business valuation.
This introduces an additional level of independent review. Rather than relying on the broker's adjusted earnings schedule, the lender uses third-party findings to evaluate the proposed add-backs.
Add-Backs Lenders Typically Accept
Certain expenses are generally easier to justify because they can be clearly documented and are not expected to continue after the acquisition.
Owner compensation and benefits. The seller's W-2 compensation, payroll taxes, health insurance, and retirement contributions are generally added back because those specific expenses end when the seller leaves. However, the lender must also account for the cost of replacing the seller's work.
One-time legal expenses. Costs related to a resolved trademark dispute, settlement, arbitration, or office relocation may qualify if they are supported by invoices and do not appear repeatedly in prior years.
Personal expenses paid through the business. Expenses such as personal vehicles, insurance, and phone bills may be added back when they can be tied to the seller and will no longer be incurred after closing.
Non-recurring professional fees. A one-time audit for an unsuccessful sale, a completed software implementation, or consulting fees for a finished project may also qualify.
The key is having documentation that shows the expense was legitimate, non-recurring, and unlikely to continue under new ownership.
Add-Backs That Require Additional Documentation
Some expenses may qualify as add-backs, but lenders will usually review them more carefully.
Family members on payroll. Suppose the seller's spouse earns $72,000 annually for handling bookkeeping and accounts payable for 15 hours per week.
The broker may add back the entire $72,000. However, the lender will consider what it would cost to replace that work.
If the responsibilities still need to be performed after closing, only the difference between the current salary and reasonable replacement compensation may be recognized.
Home office and personal expenses. These may be accepted when supported by detailed records showing that the expenses are personal and will disappear after the acquisition.
A general adjustment labeled "owner personal expenses" without supporting documentation is unlikely to receive credit.
Travel and meals. These expenses often include a combination of personal and legitimate business costs.
Lenders generally recognize only the personal portion that can be identified and supported through financial records.
Above-market rent paid to a related party. If the business pays rent to a property owned by the seller or a related party, the lender may adjust the expense to reflect market rates.
However, the adjustment generally depends on the lease being revised at closing and supported by a market rent assessment.
Add-Backs Lenders Typically Reject
Other expenses are much harder to justify because they represent normal operating costs or cannot be verified.
Deferred maintenance and recurring capital expenditures. A $80,000 website replatform, equipment upgrade, or warehouse improvement may be presented as a one-time expense.
But if the business will need to replace or maintain those assets again, the lender may treat the expense as part of the ongoing capital requirements rather than a true add-back.
Underwriters may also deduct a reserve for future capital expenditures that are not otherwise financed.
Growth-related expenses. Marketing campaigns, new hires, and sales channel experiments are generally operating expenses, even when the seller argues they were investments in future growth.
The lender evaluates the earnings the business actually generated, not what it might have earned without those expenses.
Unreported revenue or unsupported adjustments. Claims that the business generated more cash than reported on its tax returns, or that expenses were overstated for tax purposes, will not generally be accepted without verifiable documentation.
SBA lenders cannot base underwriting on income that was never reported or cannot be substantiated.
Expenses described as one-time but incurred repeatedly. If an expense appears in 2023, 2024, and 2025, the lender is unlikely to consider it non-recurring, regardless of how it's described in the CIM.
Accounting for the Cost of Replacing the Seller
One of the most important adjustments buyers overlook is the cost of replacing the seller's role in the business.
SDE assumes one working owner.
If the lender adds back $180,000 in seller compensation, that doesn't mean the buyer can automatically use the entire amount for debt service.
Someone still needs to perform the work.
If you plan to operate the business yourself, the lender will generally account for a reasonable owner draw based on your living expenses and personal financial obligations. Depending on the size of the business and your circumstances, that could range from $80,000 to $150,000.
If you plan to hire a general manager, the lender will deduct the market-rate cost of that position, including salary, payroll taxes, and benefits.
For buyers planning to keep their current jobs or operate multiple businesses, this expense can significantly affect the amount of financing available.
It's important to estimate these costs before signing an LOI rather than discovering them during underwriting.
Our complete due diligence guide covers additional areas buyers should evaluate early in the acquisition process.
Example: How Add-Backs Affect SBA Financing
The following example is hypothetical and illustrates how a lender's adjustments can change the financing available for an acquisition.
Assume a business is listed for $3.6 million with $900,000 in reported SDE.
That represents a purchase price of four times the broker's adjusted earnings.
Because the purchase price exceeds $3 million, the lender orders a quality of earnings report under the applicable SOP.
After reviewing the financial statements and proposed add-backs, the lender arrives at the following adjustments:
| Item | CIM Amount | Lender-Recognized Amount |
|---|---|---|
| Net income, interest, depreciation, amortization, owner compensation and benefits | $568,000 | $568,000 |
| Personal vehicles and insurance | $28,000 | $18,000 |
| One-time legal expenses (documented trademark dispute) | $55,000 | $55,000 |
| Travel and meals | $41,000 | $10,000 |
| Spouse on payroll | $72,000 | $18,000 |
| Home office, phones, and other personal expenses | $19,000 | $6,000 |
| Website replatform (claimed as one-time, but occurred twice) | $80,000 | $0 |
| Unreported cash adjustment | $37,000 | $0 |
| Unfinanced capital expenditure reserve | N/A | ($35,000) |
| Total | $900,000 | $640,000 |
The broker's schedule shows $900,000 in earnings, but the lender recognizes only $640,000.
That $260,000 difference has a significant effect on the loan structure.
How It Affects Debt Service Coverage
Assume the buyer plans to finance the $3.6 million purchase using:
- SBA 7(a) loan: $2,880,000 (80%)
- Seller note on full standby: $360,000 (10%)
- Buyer equity injection: $360,000 (10%)
For this example, assume a 10-year amortization period and a 10.5% interest rate.
Actual SBA 7(a) rates are generally tied to the Wall Street Journal Prime Rate plus a lender spread and may fluctuate over time. The rate here is for illustration only.
At these terms, annual debt service is approximately $466,000.
Using the broker's reported $900,000 in SDE, the debt service coverage ratio (DSCR) appears to be 1.93x.
However, the lender recognizes only $640,000 in earnings.
If the buyer plans to operate the business and requires a $90,000 annual owner draw, cash flow available for debt service falls to $550,000.
That produces a DSCR of approximately 1.18x.
Under the 1.25x minimum required for initial acquisitions by SOP 50 10 8.1, the proposed loan would not meet the coverage requirement.
How Much Financing Can the Business Support?
At a 1.25x DSCR, $550,000 in available cash flow supports approximately $440,000 in annual debt service.
Using the same loan terms, that translates to a maximum loan of approximately $2.72 million.
The original structure requires $2.88 million in SBA financing, leaving a shortfall of about $160,000.
Now consider a buyer who wants to hire a general manager rather than operate the business personally.
If the fully loaded management cost is $115,000 annually instead of a $90,000 owner draw, available cash flow drops to $525,000.
That reduces DSCR to approximately 1.13x and the maximum loan amount to roughly $2.59 million.
In this example, hiring a general manager instead of operating the business yourself reduces borrowing capacity by nearly $130,000.
What Can Buyers Do When the Numbers Don't Work?
If the lender's adjusted earnings don't support the original financing structure, there are four primary options.
1. Renegotiate the purchase price. Based on the example above, the purchase price may need to come down from $3.6 million to approximately $3.4 million to support the available financing.
2. Increase the equity injection. Contributing more cash reduces the loan amount needed and lowers the required debt payments.
3. Increase the seller note. A larger seller note on full standby may help cover the financing gap without adding payments to the debt service calculation.
4. Consider a different financing structure. If the business cannot support the proposed SBA loan, another financing option or transaction structure may be necessary.
Extending the loan term generally isn't an option for acquisitions consisting primarily of goodwill. These loans typically amortize over 10 years, while financing involving real estate may allow terms of up to 25 years for the applicable portion.
It's also important to remember that SBA 7(a) loans have a statutory maximum of $5 million.
For acquisitions requiring larger loan amounts or involving buyer profiles and transaction structures that don't meet SBA requirements, our FLEX program offers financing up to $10 million, while our Capital Access program serves larger transactions.
What Buyers Should Do Before Signing an LOI
Before committing to a purchase price, review the broker's earnings adjustments and determine which ones a lender is likely to recognize.
Separate the add-backs into three categories: those supported by clear documentation, those requiring further review, and those unlikely to be accepted.
Then calculate the business's ability to cover the proposed loan payments using the adjusted earnings figure, including the cost of replacing the seller's role.
You can use our deal affordability calculator to evaluate the numbers and review our complete SBA 7(a) acquisition guide for more information about the underwriting process.
If you're considering an acquisition and want to understand how lenders are likely to evaluate the business's earnings, get prequalified.
Our team can help review the proposed add-backs and assess the financing structure before you commit to a purchase price.