By Ryan Murphy, Managing Director, Transaction Advisory Services
On September 25, less than a week before SOP 50 10 8.1 took effect, SBA published a set of Technical Policy Updates that meaningfully changed how change-of-ownership deals are handled. Some of the most significant revisions touch the two areas getting the most attention in this SOP: the quality of earnings (QoE) requirement and business valuations.
We compared the updated SOP against the original 8.1 text line by line. Here’s what changed and what it means for lenders navigating the new requirements.
Buyers Can Now Bring Their Own QoE, With Conditions
The original 8.1 text barred a QoE prepared by or for the borrower or the seller. The update removes the borrower from that restriction. A QoE still cannot be prepared by or for the seller.
SBA now recognizes that many buyers commission their own QoE before they ever approach a lender, and the SOP lets lenders put that work to use. How it plays out depends on who prepared the report:
- The buyer’s QoE provider is on the lender’s approved vendor list. An access letter among the bank, the borrower, and the QoE provider should be sufficient for the underwriting file, with no additional services or cost. The lender has already vetted the provider; what it needs is the right to receive and use the report. This assumes, of course, the QoE was performed for the benefit of the lender and the QoE meets the requirements laid out in the SOP.
- The buyer’s QoE provider is not on the lender’s approved vendor list. This is where the SOP’s review provision applies. The lender has the report reviewed by one of its approved vendors, and the vendor’s findings must be kept in the loan file alongside the original report. A lender cannot use a QoE prepared by another party without that review.
SBA frames the change as a way to help mitigate costs. The real savings come from avoiding a second, full QoE, not from making the diligence itself lighter. The key takeaway is that buyers who do diligence early are no longer forced to start over. Lenders, however, need an approved vendor roster that reflects the providers they will actually see, along with a defined review process for reports that fall outside the roster. That review deserves more thought than the SOP gives it.
What a QoE Review Should Actually Involve
When the buyer’s QoE provider is not among the lender’s approved vendors, the SOP requires a vendor review but does not specify what that review entails. There is no required scope, no minimum procedures, and no defined deliverable. That leaves each lender to set its own standard, and the temptation could be to treat the review as a quick read of the buy-side report and a box check.
That approach defeats the purpose. The lender still has to underwrite to QoE earnings, and the buy-side report was prepared within the buyer’s scope, on the buyer’s timeline, and for the buyer’s purposes. A review that doesn’t test the underlying work adds little value.
Reviews of another firm’s QoE are common in private equity M&A, and LCG has performed a number of them over the years, as well as having our own work reviewed by peers. Based on that experience, a best-practices review should include:
- The full support package, not just the report: Obtain the buy-side firm’s report, its detailed working files, and the support underlying its conclusions.
- Fresh data from the source: Pull current financials and general ledger data directly from the seller’s accounting system and compare them with the inputs the buy-side firm used.
- A detailed review of the entire support package: provided by the buy-side firm, rather than a sample of the headline schedules.
- Validate the approach of every add-back: Review each adjustment and its supporting details, including reperformance of selected calculations, to gain comfort with both the math and the approach.
- A robust diligence meeting with the buy-side firm to walk through its process and approach and to resolve specific items identified during the review.
Done properly, a review is real work. A reasonable planning assumption is a fee roughly half that of a full QoE. When the underlying report is sound, the trade-offs favor the review, resulting in a faster turnaround than commissioning a new QoE and making the process much less burdensome for the seller, who does not have to sit through a second full diligence process.
A Review Is the Exception, Not the Default
The new review path doesn’t change what we consider best practice. Wherever possible, the lender should engage the QoE provider directly from the outset. A direct engagement gives the lender control over scope and timing, and ensures the work is designed around SBA requirements from day one. The review path exists for one situation: a buyer who comes to the bank having already commissioned a QoE for their own purposes. It is not a reason to encourage buyers to order their own QoE first.
Potential Roadblocks
Even when a buyer-commissioned QoE exists, a review won’t always be the most efficient approach. Issues we expect lenders to encounter include:
- A report that isn’t SOP-compliant: Many buy-side QoEs are scoped for the buyer’s deal, not for SBA. Common gaps include too few periods scoped in, no reconciliation to tax returns or IRS transcripts, minimal support for add-backs, and no proper proof of cash.
- Work that falls short of industry standards: Sometimes the issue is execution rather than scope; the underlying work was not performed to the quality standards generally accepted in the QoE industry.
- Unaddressed inconsistencies in financial performance: Unexplained swings in revenue, margins, or balance sheet accounts that the report doesn’t address, or discrepancies between the data the provider used and the seller’s current books.
- Stale periods: A QoE completed months before the loan application may not cover the most recent trailing twelve months, requiring a bring-down to more recent results.
- Limited access to working papers: Some providers won’t share their files or will do so only after the reviewer signs an access letter. Without the working papers, a meaningful review isn’t possible.
- Buyer-oriented adjustments: Pro forma or run-rate adjustments that make sense in the buyer’s model, such as expected synergies or planned cost reductions, may not be appropriate for SBA underwriting, where earnings must reflect how the business actually operates.
- Independence questions: A provider that also served as the buyer’s broker or deal advisor, or whose fee depends on the deal closing, may not offer the independence the SOP expects of a QoE.
When these issues arise, the reviewer can often close the gaps with supplemental procedures, but the time and cost can approach those of a full QoE. In some cases, the more efficient approach is for the lender to engage a new QoE directly. Lenders should set expectations with buyers early: a buyer-commissioned QoE is a potential starting point, not a guaranteed shortcut.
A Note on “Reliance” Letters
Much of the market talk about “reliance letters” traces back to SBA itself. Its September 25 information notice describes a buyer-commissioned QoE being used with a reliance letter or a secondary review by another firm, while the SOP text, which governs, calls for a review by one of the lender’s approved vendors. Many lenders also know reliance letters from other parts of the SBA file, such as environmental reports, where they are routine. So it is natural for a lender to ask for one on a QoE.
The confusion is mostly about the word. To a lender, “reliance” usually means permission to use a report in its credit decision. To a CPA firm, it has a specific legal meaning: the provider takes on a duty of care to a party that is not its client, and that party gains the right to bring claims over the work. A QoE is a consulting engagement, not an audit or other assurance engagement. It is performed for a specific client under a scope agreed with that client, and it does not result in a formal opinion. For those reasons, QoE providers do not extend legal reliance to parties who are not their clients, and reliance letters in that sense are not standard practice in the QoE world.
What lenders actually need, and what is standard practice, is an access letter, sometimes called a release or non-reliance letter. The lender, the borrower, and the QoE provider sign a letter that gives the lender access to the report, and the working papers where needed, for use in its underwriting. In exchange, the lender acknowledges that the work was performed for the provider’s client under that client’s scope and agrees not to bring claims against the provider. The letter typically also restricts further distribution and protects the confidentiality of the seller’s information. It is a best practice because it makes sharing possible at all, since providers generally will not release reports or files without one, and because it sets clear expectations for everyone involved.
The key point for lenders: signing an access letter does not stop the lender from using the QoE. The lender can still underwrite to the report’s findings, use its adjusted earnings in the DSC calculation, and keep it in the loan file. What the letter disclaims is the legal relationship, not the information. Likewise, when the SOP says a lender may not “rely” on a QoE prepared by another party without a vendor review, it is using the word in the everyday sense of basing a credit decision on it.
A lender’s comfort ultimately comes from the quality of the work, either because the report was prepared by a provider the lender has already vetted or because one of its approved vendors has reviewed it. A letter cannot substitute for either. And a lender that wants its own direct engagement with the QoE provider can have it by following the best practice above: engage the provider from the start.
Cash Proof Scope Flexes for Younger Businesses
Every required QoE must still include a Cash Proof that reconciles bank activity to the income statement and tax returns on a trailing 12-month basis and for the last two fiscal years. The update adds a practical fix: if the acquired business has operated for less than two years, the scope can be reduced accordingly.
Special Purpose Properties: No QoE, More Valuation Rigor
The update establishes a new framework for acquiring owner-occupied Special Purpose Properties, meaning limited-market properties whose design or construction restricts them to their specific use. SBA cites storage units and hotels, where the real estate fully secures the loan, as examples. For these transactions:
- A QoE is not required, regardless of the business purchase price. However, a business valuation and all other financial due diligence are still required.
- The valuation must allocate separate values to land, buildings, equipment, and intangible assets, and the appraiser must have completed at least four going-concern appraisals of comparable property within the past 36 months.
- Loans may carry maturities of up to 25 years when 85% or more of total project costs are for real estate.
- When the appraised value fully collateralizes the loan, lenders may use projections to satisfy the DSC requirement, provided coverage is achieved within two years of funding. Historical DSC must still be calculated and explained.
The New 24-Month Line for Employees and Insider Buyers
The update sets a clear 24-month employment threshold to determine whether a QoE applies.
An employee who has worked in the business for at least 24 months can buy out a single owner, or join existing owners in a buyout, under the Owner Buyout category, which is not subject to the QoE requirement. A buyer employed for less than 24 months is treated as an Initial Acquisition for credit purposes. That means Initial Acquisition DSC, equity injection, and QoE requirements apply, although the seller may remain as an owner and employee. For lenders, documenting the buyer’s tenure is now a gating item in determining which diligence the deal requires.
Relief for Smaller Deals
Under the original 8.1 text, every change of ownership required an independent valuation from a qualified source. The update allows the lender to perform its own valuation when the business purchase price is $350,000 or less, unless there is a close relationship between buyer and seller. Separately, 7(a) Small and SBA Express loans, which were previously barred from financing changes of ownership, are now permitted, subject to the full Appendix 15 DSC standards.
Other Items Worth Noting
Several additional changes affect how deals are structured and documented. Working capital true-ups under the purchase agreement are not treated as seller rebates and need not be applied to the loan. When a lender waives the equity injection, it may still disburse a de minimis amount of excess proceeds, capped at the greater of $10,000 or 0.5% of the loan. Verified prepaid expenses now count toward equity. For non-delegated submissions, the QoE must now be submitted with the application alongside the business valuation. And for acquisitions of a division or segment, lenders may use alternative third-party verification only when tax transcripts or financials that identify the segment cannot be obtained.
What Hasn’t Changed
The core QoE requirement remains intact. It still applies to initial acquisitions and business expansions with a purchase price of $3 million or more, measured before buyer equity, seller debt, or other financing. The report must still reconcile accountant-prepared financials, tax returns, internal statements, and IRS transcript data; document all add-backs; and assess revenue quality and customer concentration. Lenders must still use QoE earnings in the DSC calculation, and PLP lenders must have the QoE formally engaged when the SBA loan number is issued.
The Takeaway
The technical updates make the QoE requirement more flexible in who can commission the work and more targeted in which deals require it, without softening what a compliant report must contain. Lenders that have not yet updated their vendor programs, intake checklists, and credit policies should do so now. Buyers and their advisors should know that early diligence can now carry into the SBA loan file, as long as it is commissioned by the buyer rather than the seller. Buyers who expect to use SBA financing can smooth the path by choosing a QoE provider that is already on their lender’s approved vendor list.
How LCG Can Help
LCG has been serving lenders, buyers, and borrowers in the SBA space for many years. Our professionals have been performing quality of earnings engagements in the lower middle market private equity world for more than 15 years, completing hundreds of engagements every year. That experience lets us bring private equity-caliber diligence to SBA transactions, scaled to the deals SBA lenders actually see.
With SOP 50 10 8.1 now in effect, our services cover the full range of support an SBA change-of-ownership or start-up loan may require:
- Quality of earnings: SOP-compliant QoE reports for initial acquisitions and business expansions of $3 million or more, including required cash proof and multi-source reconciliations.
- QoE reviews: Reviews of buyer-commissioned QoE reports, conducted to the standard described above rather than as a box-checking exercise.
- Business valuations: Valuations supporting the business purchase price in changes of ownership.
- Business plans and financial projections: For start-ups, newly formed businesses, and transactions where the SOP requires projection-based underwriting, including asset purchases without continuity of operations and qualifying Special Purpose Property acquisitions.
- Feasibility studies: Independent assessments of market demand and financial viability for start-ups, expansions, and special-purpose projects.
Whether you are a lender expanding your approved vendor list, a buyer preparing for an SBA-financed acquisition, or an advisor guiding a client through the process, we welcome the conversation.
About LCG
LCG Advisors has provided third-party due diligence and transaction advisory services since 2003. Our Transaction Advisory practice completes 350 to 400+ Quality of Earnings engagements annually, with thousands completed across the firm’s history, primarily in the lower middle market.
Have questions about the new requirements or need to get started on a Quality of Earnings engagement? Contact Ryan Murphy at [email protected] to discuss your transaction.