Challenges with Discretionary Earnings Add-backs for SBA Financing
In my role as a business broker, I've observed that discretionary earnings addbacks frequently present challenges for securing Small Business Administration (SBA) financing.
Here are five reasons why aligning these addbacks with SBA guidelines is essential:
Lack of Standardization: The absence of a universally accepted standard for legitimate addbacks results in inconsistencies in earnings reports and evaluations. This lack of uniformity complicates the lender's ability to accurately assess a business's profitability and cash flow.
Verification Challenges: Addbacks often encompass expenses that the owner may consider non-recurring or non-essential. However, these expenses, such as one-time repairs, personal expenditures, or unusually high discretionary spending, can be difficult to verify and may not be recognized as legitimate by lenders or the SBA.
Influence on Loan Eligibility and Terms: SBA loans are predominantly approved based on a business's demonstrated cash flow, which indicates its ability to repay the loan. Earnings inflated by addbacks may misrepresent the financial health of a business, potentially leading to unsuitable loan amounts or loan application rejections due to financial authenticity concerns.
Implications for Future Business Performance: Heavy reliance on addbacks may indicate that the business's core operations are insufficient to independently sustain the loan, potentially signaling financial instability or unsustainable practices without the specific expense strategies employed by the current owner.
Regulatory and Compliance Risks: SBA loans require strict compliance. Discoveries of improper classification or justification of addbacks during financial audits can trigger complications, including demands for early loan repayment or violations of loan agreements.
Given these challenges, it is crucial for business owners to meticulously prepare and scrutinize financial statements to ensure that all addbacks are thoroughly documented, justifiable, and compliant with SBA guidelines to facilitate the loan application process.