Hi Reader

Say you tell me you have a deal working. Under LOI, lender engaged, diligence starting, and you feel good about closing this fall.

I'd be glad for you. Then I'd ask one question that would change the rest of the conversation.

"When is your lender pulling your SBA loan number?"

Most buyers have never been asked that. It sounds like paperwork. Right now it is the most important date in your deal, and almost nobody is tracking it.

On October 1, SBA's new rulebook — SOP 50 10 8.1 — takes over every 7(a) business acquisition. All the acquisition rules were pulled out of the old chapters and rebuilt into one new section, Appendix 15, which controls whenever it conflicts with anything else. It is the biggest rewrite of these rules I have seen.

I read the new version against the old one, line by line. Here are the nine things that matter.

1. The loan number is what starts the new rules. Not October 1.

If your application gets an SBA loan number on or after October 1, you are underwritten under the new rules. Lenders keep using the old rules for applications submitted through September 30.

Read those two sentences together and you'll see the problem. They don't cover the deal that goes in during late September and gets its number in early October.

If this works like past rule changes, the loan number decides it. Submit on September 28, get your number on October 3, and you are a new-rules deal. The date you submitted won't help you.

That moves the risk somewhere most buyers never look: the waiting line inside SBA's system. Delays there are normal. They are also nobody's fault, which is why nobody plans for them.

You saw this last fall. The government shut down on a fixed date. Deals that already had loan numbers got funded. Deals still waiting in the E-Tran queue did not. Nothing was wrong with those deals. They were just in line when the door closed.

So call your lender this week and ask two things: What date do you expect my loan number? How much room are you leaving before September 30?

"We'll submit in late September" is not an answer. That is exactly where the deals that lost last fall were sitting.

And if the honest answer is that your number lands close to the line, price the deal under the new rules now. Then treat beating the date as a bonus instead of a plan.

2. The coverage rule changed. Not the way you're reading about it.

Debt service coverage is the test your lender runs to see whether the business earns enough to pay the loan. A 1.25 means the business earns 25% more than the loan payments.

You will read that the required number went from 1.15 to 1.25. If you price your deal off that, you will price it wrong. Three things actually changed.

You can no longer use projections. The old rule let you hit the number using either past results or a forecast. The new rule says the lender has to look at your forecast but cannot use it to meet the test. From October 1, the business has to cover the loan on what it has already earned.

The 1.25 is not new to most buyers. Most good acquisition lenders were already requiring 1.25 on their own. What changed is who controls it. It is SBA's number now, so your banker cannot stretch it for a strong buyer the way he used to.

Lenders are now applying it to every year they look at. Not the best year. Not an average.

That third one costs the most. Take an ordinary business earning $700,000, then $760,000, then $820,000 over three years. It is growing. Nothing is wrong with it.

Year that has to pass the test

What you can finance

Last year ($820,000) Loan = $4,501,000

Two-year average ($790,000) Loan = $4,337,000

The weakest year ($700,000) Loan = $3,843,000

Same business. A difference of $659,000 in what you can pay, based only on which year the lender uses. It hurts most if the business has uneven years, or one bad year from losing a customer or opening a location.

But the all-years test is not actually in the rulebook. The rule says coverage is met using either the last fiscal year or a two-year average. The SOP does ask the lender to analyze three years. Analyzing three years and requiring all three to pass are not the same thing.

So if your lender is making every year pass, that is their policy, not the rule, and you can point to the rule. You might still lose. A lender is always allowed to be stricter than SBA. But "the rules require this" and "we require this" are different problems, and only one of them can be negotiated.

3. Budget for a quality of earnings report. Then go book it this week.

If the purchase price is $3 million or more and you are buying a business you don't already own part of, a quality of earnings report is now required. A QoE is an outside accountant's check of whether the seller's reported profits are real.

Three things about the new requirement are stricter than buyers expect.

It has to be independent and hired by your lender. Not by you, and not by the seller. A report the seller already paid for will not count.

It has to reconcile the seller's financial statements, tax returns, internal records, and IRS transcripts against each other.

And it has to include something called a Cash Proof. The accountant rebuilds the company's actual cash in and cash out from the bank statements, then matches it to the profit and loss statement and the tax return. That covers the last twelve months plus the two years before that.

The Cash Proof is what makes this expensive for sellers who have been generous with add-backs. Personal vehicles on the books, a family member on payroll, a "one-time" expense that shows up all three years. And because your lender has to use the QoE's profit number in the coverage test, anything the report takes out comes straight off your loan.

Cost today is $15,000 to $30,000, and the work takes two to three weeks.

The cost isn't the problem. On October 1 this becomes required on every $3 million-plus acquisition in the country, and there are not enough firms that can do a real Cash Proof. Calendars will fill. So plan on two to three weeks plus a wait, and understand that nobody can tell you today how long that wait will be.

This connects back to item 1. If your lender uses delegated authority, the QoE does not have to be finished when your loan number is issued. But it does have to be formally started — the firm hired, the engagement letter signed.

So the thing that gets you across the line is a signed QoE engagement letter. Every other buyer racing the same date needs one too, from the same short list of firms. Book a slot before you know whether you need it.

One piece of good news: what you spend on these reports counts toward your down payment.

4. Check where your down payment is coming from.

Ten percent down on every kind of acquisition. If you are a first-time buyer, it cannot be reduced or waived at all. If a lender has told you they can get creative for a strong buyer, that ends October 1.

Where the money comes from now matters as much as the amount. Three sources are treated as limited: money you borrow that sits on full standby, a seller note on full standby, and money from small outside investors. Together, those cannot cover more than half your down payment. On a $450,000 down payment, at least $225,000 has to be your own unborrowed money.

Then there is the rule that is pushing deals to close early. It gets reported wrong almost every time.

If investor money is being used to meet your down payment, those investors cannot receive anything except money to cover their taxes until the SBA loan is paid off.

You will see that described as a brand new lockup. It isn't. Loan covenants already said no distributions beyond tax distributions without lender consent. The restriction has been there.

What changed is the consent.

In practice, lenders got comfortable. Once the loan had seasoned and the business had proven out, they would approve distributions. Usually somewhere around year four or five. Sometimes sooner if the numbers were strong. That was the deal everyone was actually underwriting to, and it is why investors were willing to wait. They were not waiting forever. They were waiting for a conversation that had a good chance of going their way.

That conversation is gone. The new rule is hard-coded. There is no consent path, no early release, no strong-performance exception. Nothing until the loan is paid off.

So the investor who was fine waiting was fine waiting for something specific. If they were modeling a year-five distribution because that is how these have actually worked, they now have to model year ten. On a ten-year loan, that is the whole term.

There is a fix, and it costs nothing if you do it early. Money above what the down payment requires is not covered by this rule. Money brought in beyond the down payment can still take normal distributions, subject to the lender's agreements — which puts it back in the old world, where consent is at least possible.

So size the down payment portion exactly, and bring the rest in as additional investment. Then only the part that has to be locked is locked. Do that when you write the term sheet, not after your investors have signed.

One more, aimed at searchers: money you spent on education, advisers, or broker fees does not count toward your down payment. If you paid for a search program and were counting it as money in the deal, take it out of your model.

5. Rebuild your model at ten years.

Acquisition loans are now capped at ten years, with no balloon payment.

If real estate is part of the purchase, you either split it into two loans or blend the two lengths together based on how the money is being used. Only the real estate part can run longer than ten years, up to twenty-five. Everything else is ten-year money.

The old approach, where a real estate-heavy deal stretched the whole loan over twenty-five years, is gone.

Take a $4 million deal with a $2.2 million building. That is 55% real estate, which used to qualify for twenty-five years. It now blends to eighteen. Annual loan payments go up about $38,000, and the earnings you need to pass the coverage test go from about $510,000 to about $557,000.

Same building, same business, same price, and you need almost $50,000 a year more to make it work.

Now the part that decides deals. On those numbers, splitting into two loans is worse than blending them. Two separate loans need about $608,000 of earnings. The blended loan needs $557,000. That is $51,000 of required earnings riding on a choice most people make without running it. Run both.

One useful new option: a line of credit can now take first claim on your receivables and inventory if 20% to 50% of what's available on day one goes toward the purchase. That helps if you're buying a business that carries a lot of inventory.

6. Ask the seller to stay twice as long.

The seller can now stay on as a paid consultant for twenty-four months instead of twelve.

Most write-ups will give that one line. It is the most useful change in the whole rulebook, because it works on the thing that actually sinks these deals.

Think about what you are buying. The owner knows the top five customers personally. He knows which crew to send on a hard job. He knows how to price work, which suppliers to trust, and why. Lenders call this owner dependence and count it against you. You will notice it about two months in.

Twelve months is not much time to move that knowledge. You get one year, one busy season, and then he is gone.

Twenty-four months is a different situation. Two full years. Enough time to meet every important customer twice, once as the buyer and once as the owner. Enough time to learn how he makes decisions, not just what the procedures are.

For licensed businesses, it can do something more. In trades like HVAC, electrical, and plumbing, the company usually operates under a license held by one qualified person, and that person is often the seller. If your state lets him keep the license while working as a consultant, twenty-four months may be enough time. Enough for one of your employees to get certified, or for you to put in the hours and qualify yourself. Whether that works depends on your state. Ask early.

Either way, ask for the full twenty-four months. Most buyers will write twelve into the agreement out of habit. Time you don't use costs you almost nothing. Running out of time costs you the business.

7. Find out if anyone in the deal owns through a trust

This change is not in the acquisition rules, which is why nobody covering the acquisition rules has caught it.

Old rule: if a trust owned 20% or more of the borrower, the trust had to guarantee the loan. The person who set up the trust had to guarantee personally only if the trust could still be changed.

New rule: if a trust owns any amount, the trust guarantees the loan, and the person who set it up guarantees it personally. Both limits are gone.

Think about who that catches. The seller keeping 8% through his family trust. The quiet investor who came in through a trust set up for estate planning and has never guaranteed anything. You, if your lawyer put your ownership in a living trust.

All of them are now personally on the hook.

Nobody sets up a trust expecting it to end up on a bank guarantee. If there is a trust anywhere in the ownership — yours, the seller's, an investor's — find it now, while it is still a conversation and not a closing condition.

Related: a seller who keeps less than 20% now has to guarantee the whole loan for two years after closing. He does not have to pledge personal property, including his house. But a seller who agreed to "keep a small piece and help out" is now guaranteeing your loan, and nobody told him that when he agreed. Have that conversation before the LOI.

8. Know which category your deal falls into.

Every acquisition now gets sorted into one of four categories, and the category sets your coverage number, whether your down payment can be reduced, and whether you need a QoE.

If your deal is not documented as one of the last three, it is treated as a first-time purchase. That is the strictest category, and it is the default.

Two things to watch.

Buying a competitor looks like the easier path, with a lower coverage number and a down payment that can be reduced. To qualify you need four things. A business you have owned for two full fiscal years. A purchase of 100% of the target. A target in the same industry group. And the same number of personal guarantors at the end, or more. Miss any one and you are back in the strict category.

Buying out a partner is where I expect the most trouble, because people design these structures themselves. Someone who does not already work at the business can buy less than 50%, and cannot end up as the largest owner. That includes ownership held indirectly through another company or a trust. If you and the founder's son each take 40% and you are the larger of the two, this is a first-time purchase.

One more: the small-loan program can no longer be used for acquisitions at all. Every acquisition runs through standard processing now, no matter the size.

9. Run the numbers on your own deal

Here is what all of this looks like on one deal.

A services business, no real estate. Price of $4,500,000, reported earnings of $820,000. That is about five and a half times earnings, a normal price today. First-time buyer, 10% down, ten-year loan, call the rate 10.5%. The loan is $4,050,000 and the payments are about $656,000 a year.

If the loan number comes on September 30: coverage is 1.25 on the reported earnings, which is what this lender wanted anyway. No QoE is required at this price, so the seller's adjusted numbers get normal review. The deal closes.

If the loan number comes on October 3: coverage is still 1.25. The ratio is not what changes. But the QoE is now required, and its earnings number is what the lender has to use.

Say the Cash Proof removes $85,000 of add-backs. That is about 10%, which is a mild result. I have seen much worse.

Adjusted earnings are now $735,000. Coverage falls to 1.12 and fails. The most the lender can support drops to $588,000 of annual payments, which means a loan of $3,631,000.

The loan just dropped by $419,000.

Cash you need at closing goes from $450,000 to $869,000. That is 19.3% of the price instead of 10%.

There is one way to bridge it. When the price is higher than the valuation and QoE support, extra money can cover the difference. That can include a seller note. But it has to be on full standby, meaning no payments at all until the SBA loan is paid off. So the gap can be closed. You are just asking the seller to turn $419,000 of his price into a note he cannot touch for ten years. Some will. Most won't like it.

Otherwise you renegotiate. The price that works on the adjusted earnings is $4,035,000, which is $465,000 less.

Same business, same seller, same buyer, same week. The only difference is which side of one date the loan number landed on.

What actually got better.

Most coverage of this will tell you SBA tightened everything. That is most of the story, not all of it.

• The seller can stay twice as long — twenty-four months instead of twelve. The best change in the rulebook.

• Diligence costs count toward your down payment, which takes some of the sting out of a required QoE.

• A line of credit can take first claim on receivables and inventory, which is real help on inventory-heavy deals.

• Past losses no longer bar every investor. Say someone who owns part of your business was once a small investor in a company that defaulted on an SBA loan. If they held under 20%, never guaranteed it, and had no control, they can now ask for an exception. SBA reviews it case by case. It does not cover PPP or COVID EIDL losses. But that door used to be closed completely.

• Online businesses finally have a path. If a business has no physical location, the lender documents how it verified operations instead of requiring a site visit that makes no sense.

• The seller's guarantee period got shorter and simpler — a flat two years, replacing a formula that ran longer.

And one that will be over-reported: the wait to refinance a seller note went from twenty-four months to thirty-six. You will see this listed as a major change. In practice almost nobody plans to refinance a seller note at year two. If you do, rebuild that part of your model. If you don't, this costs you nothing — and I would rather tell you which changes don't matter than pad the list.

Six weeks.

If you are under LOI now: get the loan number date in writing, have your lender run the deal both ways, book the QoE, confirm your category, and tell any seller keeping under 20% about the guarantee.

If you are signing an LOI in September: assume the new rules apply. You are not getting through underwriting and issued a number before September 30.

If you are still looking: plan on about five and a half times earnings as your financing ceiling, budget the QoE above $3 million, and assume 10% down that cannot be waived and cannot be more than half covered by seller notes and investor money.

None of this makes it harder to buy a good business. Every change pushes in the same direction: the business has to pay the loan out of what it already earns, not what you believe it will earn. That is just a description of a business worth buying.

Big changes coming. But deals will still close - including yours, if you plan accordingly.

And remember, we're about to have an SBA closing traffic jam between now and October 1, so knowledge + action + speed is the critical combo.

Working a deal that straddles the date? Hit reply and tell me where you are. I read these.

Stay safe.

Eric Hsu

→ @lawyer4smbs

P.S. Forward this to the buyer you know who is "closing this fall." The most useful question you can ask them is the one nobody is asking: when is your lender pulling the loan number?

The one-page version: old rule, new rule, the four categories, and the October 1 timeline on a single page. Download it here.​