redactedIn case you missed the last article, there are some big SBA changes taking effect on October 1. I’ve been on a tear meeting with professionals that are going to be affected by the changes. The details are still being worked out in real time. Speaking of real time, you can watch us discuss these changes live on the video podcast thing at the top of the page. I recently sat down with Angel Rosario, an SBA lender at WSFS bank, and Eric Glickstein, a commercial loan broker at Commercial Loans Made Easy. We covered what’s actually changing, what it means for buyers, and where the open questions still are. Here’s what came out of it. Bigger Loans, If You Can Find the Bank In the past, the 7(a) and 504 programs used to be capped as a combined ceiling where a real estate purchase and a business acquisition had to share the same roughly $5.5 million pool. The new changes will decouple that cap. In theory, a borrower could still do a full $5 million (or $5.5 million, depending on guarantee percentage) 504 loan on the real estate and a separate $5 million 7(a) loan on the acquisition itself. But, in theory, most transactions simply won’t have enough real estate value to make it worth structuring that way. Still, there are specific deals that can be done. Angel gave an example of one with a $2 to $4 million piece of real estate that can get a 504’s fixed 25-year rate, paired with an acquisition that goes through 7(a) separately. The more consequential change is industry-specific. Certain NAICS codes (mostly manufacturing, grocery, and the logistics businesses that support the grocery supply chain) now have access to lending limits up to $10 million. In the past, the cap was $5 million for everyone. Of course, the catch now is trying to find a bank that will actually write that check. A $10 million SBA 7(a) loan with limited collateral is a very different risk conversation than the deals most SBA lenders are used to approving. Expansion Just Got More Flexible The rule for business expansion acquisitions used to require the target business to match the buyer’s exact six-digit NAICS code. This requirement added another barrier because most business owners have no idea what their own NAICS code is. It’s usually determined by whatever their CPA or bookkeeper filed. Now the requirement only matches the first four digits, which widens what counts as an “expansion” for an existing, cash-flowing business. Instead of needing to buy a direct competitor, an owner can now acquire a business found in the same broader vertical. The Quality of Earnings Mandate — and the Questions Nobody’s Answered Yet For any business expansion or acquisition where the purchase price is $3 million or more, lenders may now require a quality of earnings report in addition to the standard business valuation. I wrote a large piece on this last week. I’m a big fan, for very biased reasons, but I do think the end result should be positive for M&A. There are a few things worth knowing if you’re anywhere near that new threshold: The $3 million trigger is based on purchase price not loan amount. During the call, you might see that there was some confusion over this, even amongst professionals. Just to clear things up, the threshold is determined before the application of buyer equity, seller debt, or other financing sources. The timing of a QoE is still up in the air. The SOP requires the QoE be completed before closing, but it doesn’t say exactly when in the process it needs to be ordered. My general advice here is that earlier is better. With more prep work done upfront, you’ll run into fewer issues down the road and work with more transparency. That said, most lenders haven’t landed on a policy yet. Another thing to note is that good faith deposits are about to get bigger. Historically, SBA lenders have collected anywhere from $2,500 to $10,000 as a good faith deposit. With QoE reports now being required, that number is likely heading toward $35,000 to $50,000 for larger deals. Fortunately for buyers, the costs for due diligence do count toward the buyer’s equity injection requirement. There is going to be a bottleneck of vendor pools. Banks are working with a limited list of approved QoE providers, which limits pricing competition for borrowers. There’s also an open question about whether the same firm should be allowed to provide both a buy-side QoE (for the buyer’s own diligence) and a lender-side QoE (for the bank’s underwriting). Will firms be allowed to provide both valuations and QoEs for the same target company? The reports do serve different purposes typically, which creates a conflict of interest, similar to a bookkeeper auditing their own books. The SOP requires the QOE to be prepared by a “financial professional,” but it doesn’t specify what that means exactly. My daughter thinks she’s a financial professional now that she has her own piggybank, but I’ve seen her QoE reports and I’ve got some questions. Angel pointed out that the professional doesn’t strictly have to be a CPA, but the implication was clearly that it should be someone with credentials. It’s safe to assume that traditional bank vendor pools will likely default to CPA-credentialed providers. However, non-traditional and alternative lenders could opt for less credentialed providers, maybe even outsourced or AI-generated models where only one person on a report-producing team is actually licensed. One of the more useful changes in the new guidance is that add-backs are expected to be verifiable. In theory, this should tighten up a process that’s historically been soft. Unfortunately, there’s no clear guidance (see the theme yet?) on how to handle the ambiguous cases. For instance, a seller who ran $20,000 of personal home repairs through the business as a deductible expense for tax purposes wouldn’t be something a QoE provider can independently verify. As a result, whether a lender accepts that add-back, discounts it, or rejects it outright is still left to individual underwriting judgment. One of my biggest gripes with the changes is the “forward-looking requirement.” I think that it’s in conflict with what a QoE actually does. The guidance says that a QOE needs to include references to future profit margins, but QoE work is built around historicals and as good as I am at helping my clients not overpay for businesses, I am not a fortune teller. That being said, I am proud to announce that zero of my clients have defaulted on their SBA loan. If you add all these changes up, you might think that our conversation was mostly negative about the new legislation. We’re pretty positive about it, actually, but there are still plenty of questions to answer and details to work out. Personal Guarantee Insurance: Early and Unproven We also talked about a new idea called personal guarantee insurance. It imagines a policy that could offset some portion of a defaulted SBA loan, reducing the exposure of a personal guarantee. If these policies become assignable to a bank the way a life insurance policy can be, it could completely change underwriting for personal guarantees. PGs remain a fixture of SBA lending regardless of how large or established the borrowing business is. For now, though, personal guarantee insurance is an unproven product, and nobody in the room had come across it yet. What This Means If You’re Buying One of the goals of regulation is to create standards and uniformity to weed out unwanted outcomes. It’s like lowering the bar in a limbo line. As it gets harder for people to make it through, people tend to get more and more creative with their limbo technique. I’m something of a scoocher myself. When this dynamic is applied to M&A, we’ll see people finding all sorts of creative ways to “get under the bar.” Keep in mind, not all brokers, bankers, and “financial professionals” are created equal. In most states, there’s no licensing requirement to become a broker of a bank. Despite the new regulations, you should still vet who’s on your team and make sure they know what they’re saying. If a deal falls apart after you’ve paid for a shoddy QoE with even shoddier consulting, you’re not getting that money back. On the plus side, if the deal closes, those costs can count towards your equity injection. As you navigate these changes and all their implications, feel free to set up some time to talk with someone who has done hundreds of QoEs.