Why Financial Due Diligence Makes or Breaks SBA Acquisitions
You’ve found a business you want to buy. The revenue looks strong, the seller seems motivated, and you’re ready to move forward with SBA financing. But before you sign a letter of intent or submit a loan application, there’s one critical step that separates successful acquisitions from expensive mistakes: financial due diligence.
Financial due diligence is the systematic process of verifying, analyzing, and understanding a business’s financial performance. It’s not just about confirming that the numbers are accurate — it’s about understanding what those numbers mean for you as the new owner, and whether the business can support SBA loan debt service while paying you a reasonable salary.
At GoSBA Loans, we’ve helped facilitate over $320 million in SBA-financed acquisitions in 2025. We’ve seen deals fall apart because buyers skipped critical due diligence steps, and we’ve seen buyers walk away from bad deals because their due diligence uncovered problems the seller didn’t disclose. In both cases, the due diligence process was the deciding factor.
This guide provides a comprehensive financial due diligence checklist specifically designed for SBA business acquisitions — covering everything from tax return analysis to the specific red flags that kill SBA loan approval.
Step 1: Tax Return Analysis (3 Years Minimum)
Tax returns are the foundation of SBA financial due diligence. Unlike profit and loss statements, tax returns are signed under penalty of perjury — making them the most reliable financial documents you’ll review.
What to Request
- 3 years of complete federal business tax returns (including all schedules and attachments)
- 3 years of personal tax returns for all owners with 20%+ ownership
- State tax returns if the business operates in states with income tax
- Sales tax returns to verify revenue independently
What to Look For
- Revenue trends: Is the business growing, stable, or declining? SBA lenders want to see stable or growing revenue
- Consistency: Do the tax returns match the P&L statements the seller provided? Discrepancies are a major red flag
- Owner compensation: How much is the owner paying themselves? This gets added back to calculate true cash flow
- Depreciation and amortization: These are non-cash expenses that get added back for cash flow analysis
- Interest expense: Existing debt service that may or may not transfer with the business
- Related party transactions: Is the business paying rent to an entity owned by the seller? Are family members on payroll?
SBA-Specific Considerations
SBA lenders will pull IRS transcripts (Form 4506-C) to verify the tax returns you’ve been provided. If the seller’s tax returns don’t match IRS records, the deal is dead. This happens more often than you’d think — always verify early.
Step 2: Normalizing Financials — Add-Backs, Owner Compensation, and One-Time Expenses
Raw financial statements rarely tell the full story. Normalizing financials — also called “recasting” — adjusts the business’s reported earnings to reflect its true economic performance under new ownership.
Common Legitimate Add-Backs
- Owner’s salary and benefits: The current owner’s total compensation (salary, health insurance, retirement contributions, personal vehicle expenses)
- Depreciation and amortization: Non-cash charges that reduce taxable income but don’t affect cash flow
- One-time expenses: Lawsuit settlement, major equipment repair, moving costs — things that won’t recur
- Personal expenses run through the business: Owner’s personal travel, meals, vehicle, cell phone, etc.
- Above-market rent to related parties: If the owner pays rent to their own LLC at above-market rates, the difference is an add-back
- Non-recurring professional fees: One-time legal or consulting costs
Add-Backs That Should Make You Suspicious
- “Cash revenue” that isn’t on the books: If the seller claims additional cash income that isn’t reported on tax returns, walk away — SBA lenders won’t consider it, and it suggests broader integrity issues
- Excessive add-backs: If add-backs represent more than 30-40% of the reported net income, scrutinize every single one
- Undocumented add-backs: Every add-back should have supporting documentation. “Trust me, that was personal” isn’t good enough
- Future-looking add-backs: “We just signed a big contract that will add $200K” — if it’s not in the historical financials, it doesn’t count for SBA underwriting
Calculating Seller’s Discretionary Earnings (SDE)
For most SBA acquisitions of businesses under $5 million, the key metric is SDE:
- Net Income (from tax returns)
- + Owner’s Salary and Benefits
- + Depreciation and Amortization
- + Interest Expense
- + One-Time / Non-Recurring Expenses
- + Personal Expenses Run Through Business
- = Seller’s Discretionary Earnings (SDE)
SDE represents the total economic benefit available to a single owner-operator. This is the number that determines valuation multiples and, critically, whether the business can service SBA debt.
Step 3: Cash Flow Verification
Financials can be manipulated. Bank statements are much harder to fake. Cash flow verification cross-references the business’s reported revenue and expenses against actual bank activity.
What to Request
- 12-24 months of business bank statements for all accounts
- Merchant processing statements (credit card processing reports)
- Accounts receivable aging report
- Accounts payable aging report
What to Verify
- Total deposits should approximate reported revenue: If the P&L shows $2 million in revenue but bank deposits total $1.5 million, you have a problem
- Seasonal patterns: Understand when cash comes in and when it goes out — this directly impacts working capital needs
- Large or unusual transactions: One-time large deposits or withdrawals should be explainable
- NSF charges or overdrafts: These indicate cash flow stress
- Loan payments: Identify all existing debt obligations
Step 4: Working Capital Analysis
Working capital — the cash needed to fund day-to-day operations — is one of the most overlooked aspects of SBA acquisition due diligence.
Key Working Capital Components
- Accounts receivable: Money owed to the business by customers. How old is it? Is it collectible?
- Inventory: What’s the current inventory value? Is it fresh or obsolete? Will you need to restock immediately?
- Accounts payable: What does the business owe to vendors? Are payables current or past due?
- Prepaid expenses: Rent deposits, insurance premiums, and other prepaid items
- Payroll obligations: Accrued wages, payroll taxes, and benefits due
Why This Matters for SBA Deals
Many SBA buyers focus exclusively on the purchase price and forget that they need cash to operate the business from day one. Consider these scenarios:
- You close on a service business and won’t collect receivables for 30-60 days — but payroll is due in two weeks
- You acquire a retail business and need to immediately restock $100,000 in inventory
- The seller has been deferring vendor payments, and you inherit $50,000 in past-due payables
The solution: include working capital in your SBA loan request. Most SBA lenders will finance reasonable working capital as part of the acquisition. Your SBA broker can help you calculate and justify the right amount.
Step 5: What SBA Lenders Specifically Look For in Financials
Understanding what SBA lenders evaluate helps you prepare — and helps you identify potential deal-breakers before you’ve invested months and thousands of dollars in due diligence.
Key SBA Underwriting Metrics
- Debt Service Coverage Ratio (DSCR): Most SBA lenders require a minimum 1.25x DSCR, meaning the business’s cash flow must be at least 125% of all debt payments (including the new SBA loan, any seller note payments, and existing debt)
- Historical cash flow trends: Lenders want to see stable or growing cash flow over the past 3 years. A business with declining revenue is a harder approval
- Industry risk: Some industries are considered higher risk by SBA lenders. Restaurants, retail, and construction often face more scrutiny
- Owner equity injection: Standard SBA acquisition loans require 10% equity injection from the buyer (some lenders require more)
- Management experience: Does the buyer have relevant experience to operate this business successfully?
Documentation SBA Lenders Will Require
- 3 years of business tax returns
- 3 years of personal tax returns for all 20%+ owners
- Year-to-date profit and loss statement and balance sheet
- Business debt schedule
- Personal financial statement (SBA Form 413)
- Business plan with financial projections
- Purchase agreement or letter of intent
- Lease agreement (if applicable)
- Franchise agreement (if applicable)
Step 6: Red Flags That Kill SBA Loan Approval
After reviewing thousands of SBA loan applications, these are the financial red flags that most commonly result in denial:
Deal-Killing Red Flags
- Tax returns don’t match IRS transcripts: Immediate disqualification. No exceptions
- Declining revenue trend: Three consecutive years of declining revenue makes approval extremely difficult
- Insufficient DSCR: If the business can’t demonstrate 1.25x coverage of all debt payments, most lenders won’t proceed
- Unreported income: If the seller claims significant cash income that isn’t on tax returns, SBA lenders won’t count it — and the deal may not underwrite
- Buyer’s credit issues: Personal credit score below 680 limits options significantly; below 650 makes SBA approval very difficult
- Criminal history: Certain criminal convictions can disqualify borrowers from SBA programs
- Industry exclusions: SBA loans cannot be used for certain business types (gambling, lending, speculation)
- Lease term too short: If the business has a physical location, SBA lenders typically require a lease term that covers the loan period (or renewal options)
- Customer concentration: If more than 40% of revenue comes from a single customer, many lenders view this as excessive risk
- Seller won’t carry a note: For most SBA deals, lenders expect the seller to carry 10-15% of the purchase price as a standby seller note
Yellow Flags Worth Investigating
- Revenue is flat but expenses are rising — margin compression may indicate underlying problems
- High employee turnover — may signal management issues or below-market compensation
- Deferred maintenance — equipment or facilities that need significant near-term investment
- Pending regulatory changes — new regulations that could affect profitability
- Key person dependency — the business relies heavily on one employee (other than the owner)
Your Financial Due Diligence Checklist
Use this checklist to ensure you’ve covered every critical area before submitting your SBA loan application:
- ☐ Obtained 3 years of complete federal business tax returns
- ☐ Obtained 3 years of personal tax returns for all 20%+ owners
- ☐ Verified tax returns against IRS transcripts (Form 4506-C)
- ☐ Reviewed year-to-date P&L and balance sheet
- ☐ Calculated and verified all add-backs with documentation
- ☐ Calculated Seller’s Discretionary Earnings (SDE)
- ☐ Reviewed 12-24 months of bank statements
- ☐ Cross-referenced bank deposits with reported revenue
- ☐ Analyzed accounts receivable aging
- ☐ Analyzed accounts payable aging
- ☐ Reviewed inventory valuation and condition
- ☐ Calculated working capital needs
- ☐ Verified debt service coverage ratio (minimum 1.25x)
- ☐ Reviewed all existing debt obligations
- ☐ Checked for customer concentration risk
- ☐ Reviewed lease terms and renewal options
- ☐ Verified sales tax filings match reported revenue
- ☐ Identified all related party transactions
- ☐ Reviewed payroll records and employee agreements
- ☐ Confirmed no outstanding tax liens or judgments
How GoSBA Loans Helps You Navigate Financial Due Diligence
Financial due diligence for SBA acquisitions is complex — and the stakes are too high to get it wrong. At GoSBA Loans, we help buyers navigate this process every day.
Here’s what we bring to the table:
- Expert deal review: We analyze the business’s financials and identify potential issues before you submit a loan application
- 50+ lender network: Different lenders have different appetites for risk, industry focus, and underwriting criteria. We match your deal with the lender most likely to approve it — and offer the best terms
- Free business plan and financial projections: SBA lenders require a business plan with projections. We provide this (a $2,500-$5,000 value) at no cost to you
- Pre-qualification: We pre-qualify your deal before you invest time and money in full due diligence — saving you from pursuing deals that won’t get approved
- 100% free service: GoSBA Loans is completely free to borrowers. We’re compensated by the lender at closing, so our incentives are fully aligned with yours
With over $320 million in SBA loans funded in 2025, we have the experience and lender relationships to get your deal done right.
Ready to start your SBA acquisition due diligence? Contact GoSBA Loans today for a free consultation. We’ll review your deal, identify potential issues, and guide you through every step of the process.
