How to Underwrite a Business Acquisition Loan

A business acquisition loan is underwritten on the business being bought, not on the buyer's history with it. The lender verifies the seller's reported revenue against the deposits in the bank statements, rebuilds cash flow from the tax returns with defensible add-backs, and tests whether that adjusted cash flow covers the new acquisition debt plus a wage for the buyer. SBA 7(a) sets published coverage floors: 1.15 times for standard loans above $350,000 and 1.10 times for 7(a) Small Loans at or under $350,000.

Acquisition credit has an odd shape. In ordinary commercial lending you underwrite a borrower whose records you can ask for and whose behavior you can watch. In an acquisition you underwrite a company the borrower does not own yet, using books the borrower did not prepare, on the assumption that the earnings survive a change of owner. Almost everything that goes wrong in these deals traces back to one of those three facts.

Start with the only independent record: the bank statements

The seller hands you a tax return, a profit and loss statement and, usually through a broker, an adjusted earnings sheet. Three documents, three numbers, all prepared by people with an interest in the outcome. The bank statements are the only record in the file that was not written to make a point.

So total what the business actually collected. Then net it, because raw deposits lie. Transfers between the seller's own accounts, loan proceeds, an owner capital contribution, a refund from a vendor and a credit card settlement batch that was already counted all show up as credits and inflate the total. What is left after you strip those out is collected revenue, and it is the number you set beside the revenue reported on the return and the profit and loss.

If those figures agree within a normal timing difference, the file gets easier from here. If collected revenue is materially below reported revenue, the seller is either recognizing revenue they have not been paid for or inflating the numbers. If collected revenue is materially above it, the business has unreported income, which is common in cash businesses and which a lender cannot count no matter how sincerely the seller explains it. Either way you have found the deal's central question in the first hour rather than the sixth week.

Rebuild cash flow from the tax returns

The tax return is written to minimize taxable income, so net profit understates what the business earns. You rebuild from it. Start at net profit, then add back the items that are either non-cash or specific to the current owner:

• Depreciation and amortization. Non-cash. They come back cleanly.
• Interest on debt that will be retired at closing, since the buyer will not carry it.
• Owner compensation and benefits, when you are computing seller's discretionary earnings for an owner-operator buyer.
• Genuinely discretionary or one-time expenses: the owner's personal vehicle, personal travel, a family member's health insurance, a non-recurring legal matter.

The judgment lives in that last bullet, and it is where credit files fall apart under review. The practical test a lender should apply is blunt: if the expense will exist again next year under a new owner, it is not an add-back. A recurring cost relabeled as one-time is the most common way an asking price gets propped up. So is a family member on payroll who actually does the job, which means the buyer will have to pay someone to do it. Deferred maintenance is the quiet one: an owner who stopped replacing equipment for three years shows better earnings and hands the buyer a capital bill.

Show every adjustment with the source line behind it. A credit reviewer should be able to accept or strike each one individually, and an add-back nobody can source is an add-back that gets struck.

Seller's discretionary earnings or EBITDA?

This is not an accounting nicety. It changes how much debt the deal can carry.

Seller's discretionary earnings, or SDE, adds the owner's entire compensation back, on the theory that a single owner-operator is stepping into that seat and will take that money as their own return. Adjusted EBITDA does not: it leaves a market-rate salary for a replacement manager sitting in the expenses, because a buyer who will not run the business day to day still has to pay somebody who will.

Match the metric to the buyer. Owner-operated small businesses bought by an individual, which describes most SBA 7(a) acquisitions and most search fund deals under a few million dollars, are financed on SDE. Companies with real management, where the buyer is a fund or a strategic acquirer, are underwritten on EBITDA. Financing an absentee buyer on an SDE figure means you have quietly lent against a salary that will never be paid, and the coverage ratio in your credit memo is wrong by exactly the amount of a manager's pay. Our breakdown of seller's discretionary earnings versus EBITDA works through both calculations on the same numbers.

Test the cash flow against the new debt

Historical earnings matter only to the extent they cover the loan the buyer is about to sign. Take adjusted cash flow, subtract what the buyer needs to live on if they are an owner-operator, and run it against the annual debt service on the acquisition loan plus any existing debt that survives closing plus any seller note that is actually paying.

SBA publishes the floors. Under SOP 50 10 8, effective June 1, 2025, a standard 7(a) loan above $350,000 is underwritten to a minimum 1.15 times debt service coverage, while 7(a) Small Loans at or under $350,000 carry a 1.10 times floor. Most lenders apply tighter policy on top of that, and they should, because an acquisition borrower has no track record running this company. Our guide to SBA loan underwriting guidelines covers the rest of the credit standards.

How does the SBA equity injection work on a change of ownership?

SBA requires at least a 10 percent equity injection on a complete change of ownership. A seller note can count toward part of that requirement, up to half of it, but only when the note sits on full standby, no principal and no interest paid, for the life of the SBA loan and is documented on SBA's standby creditor agreement. That single rule reshapes how these deals get structured, because a seller who expected to be paid monthly out of the business is now waiting a decade. The injection also intersects with the appraisal: since the SBA loan is capped at the business's appraised value, any gap between an agreed price and a lower valuation typically gets bridged by that same standby seller note, which is where the SBA business valuation requirements come in. SBA policy moves, so confirm the current SOP before you structure anything on it.

What documents do you need to underwrite an acquisition?

At minimum: three years of business tax returns, an interim profit and loss statement and balance sheet, twelve months of business bank statements, the debt schedule, the purchase agreement or letter of intent, an equipment and asset list, and the buyer's personal financial statement and resume. The bank statements do the verification work, the returns do the earnings work, and the debt schedule tells you what survives closing. Anything the seller cannot produce is itself a finding.

What red flags kill an acquisition loan?

Revenue that does not appear in the bank account. Earnings that depend on the owner's personal relationships with the top two customers. A concentration where one client is 40 percent of sales. Add-backs that recur. A seller who will not put a note on standby, which usually means they do not believe the business will service the debt either. Non-sufficient-funds activity and negative balance days in the statements, which say the business was already tight before anyone added acquisition debt to it. Reading NSF activity and negative days correctly matters here, because a business that overdrafts in a good year will not survive a debt payment in a bad one.

Do you need a quality of earnings report?

On a larger deal, yes. A quality of earnings engagement is a full accounting review with an opinion attached, and the five-figure fee is cheap against a seven-figure mistake. On a small owner-operated acquisition the economics rarely support one, which is exactly why the document analysis has to be done properly: the deposit reconciliation, the add-back schedule and the coverage test are the diligence. That analysis is what business acquisition underwriting software automates, reading the statements and returns and computing the numbers with each figure traceable back to the page it came from, and it is the same tax return analysis a lender runs on any self-employed borrower.

One practical note for the buyer rather than the lender: the day after closing, you inherit the bookkeeping too, and most sellers hand over a shoebox. Getting the historical statements into your accounting system as clean QBO files before the first month closes saves a painful reconstruction later.

The short version

Verify the revenue against the bank account. Rebuild the earnings from the return, and make every add-back defend itself. Pick SDE or EBITDA based on who will actually run the business. Then test the coverage against the real debt stack, including the buyer's wage. Deals that fail do not usually fail on structure. They fail because somebody believed a number nobody had checked.