Underwriting companies with spiking earnings

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June 06, 2024

by a searcher from University of Illinois at Urbana-Champaign in Dallas, TX, USA

Looking at expanding through acquisition and have connected with a company who has prepared for selling by improving their margins in the last###-###-#### months. As a result, their TTM shows a 50% growth in earnings relative to their last tax return.

So my question is whether there are SBA programs that would allow a QoE or audit to verify the TTM earnings and we could underwrite a deal accordingly? Otherwise, are there conventional programs that could underwrite against the TTM?

Am hoping that this provides a path for others in similar positions.

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Reply by an intermediary
from Creighton University in Los Angeles, CA, USA
The SBA 7(a) loan program offers flexibility in underwriting, especially for loans under $500,000. Lenders can use their own policies and include TTM earnings in cash flow analysis. For loans over $500,000, the standard 9-point criteria can be applied, also allowing TTM earnings.

Quality of Earnings (QoE) or Audit - While not required by SBA guidelines, lenders can incorporate QoE or audits as part of their due diligence to ensure accurate and reliable financial data. In fact, we've built an automated QoE product that gets you a proof of cash statement in minutes at 10% of the cost. Happy to chat with you deeper about it here [https://calendly.com/garrettdealwise/dealwise]

Fraud and Eligibility Checks - The SBA conducts upfront fraud and eligibility checks via APIs connected to various databases, providing timely assurance of loan eligibility.

Conventional Underwriting - Conventional lenders use TTM earnings in their financial analysis, reviewing income statements, balance sheets, and cash flow over the trailing twelve months to assess business health. They may also require a QoE or audit to verify financial data.

Conclusion - The SBA 7(a) loan program offers a flexible framework that includes TTM earnings in the underwriting process. Lenders can use their own policies and may include QoE or audits. Conventional lenders also commonly use TTM earnings, making it a viable option for businesses like yourself.
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Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
One of the issues with the SBA 7A loan program is lenders and the SBA typically want the cash flow to work based on at least one historical tax year and tax return. So getting a deal done based on a TTM price and cash flow if it does not hit a 1.25x debt service coverage ratio in 2023 is going to be very unlikely if almost not impossible. One option you might have is to build in a large seller note and put it on standby for two years (possibly even have it partially forgivable) and let the seller know that they have to wait for part of the money for after you can prove the cash flow continues. You might be able to come up with a creative solution.

Conventional Bank lenders are going to be even more concerned about cash flow. You could look at some non-bank / private lenders, but you are likely looking at a significantly greater down payment.

Aside from the above, I would highly caution against buying a business based off of only 12 months of cash flow. That is not a long-enough time period to confirm it is sustainable. There are a lot of things a seller can do to boast sales temporarily. Unless it has been having consistent growth year-over-year at the level for several years, I would be cautious. Happy to discuss ideas in more detail at redacted Good luck.
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