The U.S. Small Business Administration's recently issued SOP 50 10 8.1 introduces a new requirement that could significantly affect lower middle market M&A transactions financed through the SBA 7(a) loan program. Beginning Oct. 1, 2026, lenders financing certain change-of-ownership transactions are now required to obtain an independent Quality of Earnings (QoE) report for acquisitions with purchase prices of $3 million or more, excluding owner-occupied real estate.

While the requirement may appear procedural at first glance, it could represent one of the most significant changes to lower middle market acquisition underwriting in recent years. By requiring independent validation of earnings, the SBA is introducing an additional layer of rigor that may influence deal timelines, valuation discussions, financing structures, and transaction certainty.

Although directed at lenders, the requirement is likely to affect a broad range of market participants, including independent sponsors, search funds, and business owners pursuing SBA-backed acquisitions. As a result, market participants may need to revisit transaction timelines, diligence processes, and financing assumptions.

A shift in underwriting expectations

Historically, many SBA-backed acquisitions have relied on lender review of financial statements, tax returns, and borrower-provided analyses when assessing the financial health of a target company. Under the new guidance, certain transactions will require a third-party QoE report commissioned by the lender. Buyer-prepared or seller-prepared reports will not satisfy the requirement.

The SBA also expects lenders to incorporate QoE-adjusted earnings into underwriting and debt service coverage analyses.

The change reflects a broader trend toward enhanced financial diligence and risk management in acquisition lending. As transaction structures have become increasingly sophisticated and reliance on adjusted EBITDA has grown, lenders and regulators have placed greater emphasis on validating the sustainability of earnings and cash flows used to support debt repayment. 

As a result, earnings adjustments, add-backs, and normalization assumptions that may have previously received limited scrutiny could face a more rigorous review process. The findings of an independent QoE report may directly influence financing capacity and the overall structure of a transaction.

Potential implications for buyers and investors

The new requirement is expected to increase financial diligence activity across transactions utilizing SBA-backed debt. Market participants should anticipate several potential outcomes:

Longer transaction timelines

Introducing an additional diligence workstream may add time to acquisition processes, particularly for deals that previously did not include a formal QoE review. Buyers, lenders, and advisors may need to adjust closing expectations accordingly.

Increased diligence costs

The requirement effectively introduces another layer of transaction diligence. As noted in discussions across the SBA financing community, the rule may lead to higher transaction costs for acquisitions that fall within the scope of the new guidance.

Greater scrutiny of adjusted EBITDA

QoE reports are designed to assess the sustainability and accuracy of a company's earnings.  

This may be especially impactful for transactions where adjusted EBITDA differs materially from reported earnings. Independent reviewers will likely evaluate management add-backs, owner compensation adjustments, one-time expenses, related-party transactions, and revenue normalization assumptions. Transactions that rely heavily on these adjustments may encounter greater financing pressure than they would have under historical underwriting practices.

As lenders increasingly rely on independently validated earnings metrics, commonly used adjustments and add-backs may receive heightened examination.

Potential changes to financing structures

If a QoE report identifies adjustments that reduce EBITDA or cash flow available for debt service, borrowers may face lower loan proceeds than initially expected. In some situations, transactions could require additional equity contributions, revised purchase terms, or alternative financing structures.

What does this mean for the SBIC market?

A common misconception is that the SBA's new guidance creates a blanket requirement for Small Business Investment Company (SBIC) funds to obtain QoE reports on all investments. That is not the case. The requirement applies to certain SBA 7(a) acquisition financing transactions rather than to SBIC investment activity itself.

However, SBIC-backed acquisitions that utilize SBA 7(a) financing may still be affected. For these transactions, the lender may require an independent QoE report as part of the financing process.

For SBIC managers, the more significant impact may be indirect. Increased lender reliance on independently verified earnings could influence valuation discussions, financing assumptions, debt capacity, and transaction execution. Over time, the requirement may also contribute to broader market expectations around financial diligence. Sellers may face increasing pressure to support adjustments with more detailed documentation, while investors may begin viewing QoE analyses as a standard component of transaction readiness rather than an optional diligence exercise. Funds operating in the lower middle market may find that they need to begin financial diligence earlier in the acquisition process and work more closely with advisors to support earnings adjustments and growth assumptions.

What will a Quality of Earnings review actually examine?

One of the most common questions buyers are asking is what lenders will expect from these reviews in practice. While every process may vary slightly, discussions with market participants suggest many SBA-backed acquisitions may utilize a streamlined "QoE Lite" approach designed to help lenders validate the sustainability of earnings and cash flows without performing a full-scale financial diligence engagement.

Although the exact scope will vary by lender and transaction, buyers should be prepared for a review focused on five key areas:

1. Historical revenue trends and revenue recognition

Lenders will want to understand how the business generates revenue and how that revenue has been recognized historically. Buyers should be able to explain revenue trends and whether revenue has traditionally been recorded when earned, billed, or cash is received.

While a formal conversion to GAAP may not be required, lenders will likely want to understand how a GAAP-based approach could affect historical revenue trends and reported earnings.

In many situations, lenders may also seek insight into the contractual nature of revenue. While a full contract review may not be necessary, buyers should understand how much revenue is recurring or contractually supported and be prepared to discuss key customer contract terms.

2. Historical gross margin performance

Lenders will also evaluate gross margin trends and seek to understand significant changes over time. This may include understanding the impact of factors such as tariffs, supply chain disruptions, labor pressures, pricing initiatives, or other operational developments.

For manufacturing businesses, discussions may focus on material costs, labor costs, overhead allocation, and inventory costing methodologies.

For software and service businesses, attention may shift toward labor utilization, hosting costs, software expenses, and other costs associated with delivering products or services.

While extensive adjustments may not be required as part of a streamlined process, lenders will often want to understand whether historical margins are sustainable and what future changes may be expected.

3. Significant operating expenses

Another key objective of a QoE review is to establish a normalized view of operating expenses. Lenders may review trends in major expense categories, including payroll, rent, insurance, professional fees, technology costs, and other significant operating expenditures.

Buyers should be prepared to identify unusual, personal, non-recurring, or transaction-related expenses that may distort the ongoing earnings profile of the business. The goal is to provide lenders with confidence that reported earnings reflect the true operating performance of the company on a go-forward basis.

4. Historical working capital trends

Lenders will often focus heavily on working capital and the components that drive day-to-day liquidity, including:

Accounts receivable

Buyers should understand the composition of both billed and unbilled receivables, including aging trends and collectability. Lenders may focus on overdue balances, historical write-offs, and whether any receivables could prove difficult to convert into cash after closing.

Inventory

For inventory-intensive businesses, lenders may review the makeup of inventory balances, including raw materials, work-in-process, and finished goods. They may also assess whether obsolete or slow-moving inventory exists and whether inventory reserves are appropriate.

Accounts payable

Accounts payable aging may be reviewed to determine whether significant liabilities remain unpaid or whether unusual payment practices have occurred historically.

Accrued expenses

Lenders may seek to understand obligations that are not reflected in historical financial reporting, including accrued payroll, bonuses, commissions, vacation pay, subcontractor costs, insurance expenses, and technology-related costs.

Deferred revenue

Businesses that receive customer payments in advance may need to evaluate deferred revenue balances. Manufacturers receiving deposits and subscription-based or service businesses receiving prepaid customer payments may need to assess whether additional liabilities should be recognized.

As part of this process, buyers should work with advisors and lenders to understand how the post-closing balance sheet could differ from the company's historical reporting practices.

5. Historical cash flows

Ultimately, lenders are trying to determine a sustainable level of cash flow available to service debt.

This analysis generally begins with earnings, often measured as EBITDA, and incorporates working capital dynamics and capital expenditure requirements. While historical cash flow statements may provide an initial indication of performance, significant adjustments identified during the QoE process can materially affect how lenders evaluate the business and its financing capacity.

Preparing for the new environment  

Buyers and advisors should consider how this requirement may affect transactions. Organizations pursuing acquisitions financed through SBA-backed debt may benefit from:

• • Assessing whether anticipated transactions are likely to fall within the scope of the requirement
  • Identifying potential diligence needs from third-party accountants earlier in the deal process
  • Reviewing support for EBITDA adjustments and normalization items
  • Building additional time into transaction schedules
  • Understanding how independent earnings analyses may affect financing capacity
  • As lenders implement the new guidance, early preparation may help reduce surprises during underwriting and keep deals on track.

Looking ahead

The SBA's new QoE requirement represents more than an additional diligence step. It reflects a broader emphasis on independently validated financial information in acquisition underwriting. For lenders, the rule provides an additional tool for evaluating risk. For buyers and investors, it may introduce new considerations around timing, cost, and financing certainty.

While the practical effects of the new requirement will become clearer as lenders develop implementation approaches, one trend already appears evident: independently validated earnings are becoming increasingly central to acquisition financing. Market participants that prepare for this shift early may be better positioned to navigate underwriting requirements, support valuation assumptions, and improve transaction execution in an increasingly competitive lower middle market environment.