Why Business Acquisitions Fall Apart, And How To Keep Yours Together

Where In The Process Deals Break

A signed letter of intent feels like the finish line. It is closer to the starting gun. Between the LOI and closing, three groups test the deal at the same time: you and your advisors in due diligence, the lender in underwriting, and third parties like the appraiser, the landlord and sometimes a franchisor.

In our experience, deals rarely die from one dramatic surprise. They die because a small problem shows up in week six that could have been found in week one, and by then everyone is tired. Each section below covers one common breaking point and what usually fixes it. For the week-by-week view of where each one shows up, see the LOI to closing timeline.

The Valuation Comes In Below The Price

Every SBA acquisition needs an independent business valuation. The lender orders it from an accredited appraiser, and the lender cannot use a valuation that was prepared for you or for the seller. If the price is higher than the value the appraiser supports, SBA requires the difference to be made up with equity. The lender cannot simply lend more.

This usually happens because the asking price was set on an optimistic multiple or on earnings the appraiser does not accept. It does not have to kill the deal. You have three ways to close the gap: the seller lowers the price, the seller carries more of the price on a note that is on full standby (no payments for the life of the SBA loan), or you bring more cash.

Now compare a price cut. If the seller instead lowers the price to $1,800,000, the project falls to $1,900,000, the Down Payment falls to $190,000 and the SBA loan is $1,710,000. With half of the Down Payment on standby, the seller receives $1,705,000 at closing. The cash at closing is almost the same either way. The higher price only adds a note the seller waits years to collect, and showing that comparison often settles the argument. Read how SBA valuations work and negotiating price and terms for more.

The Earnings Do Not Match The Tax Returns

The lender does not take the listing's numbers on faith. It analyzes the last three year ends of the business at the highest level of reporting available, plus the current interim statement and the same period last year. It also checks the seller's financial data against IRS tax transcripts. If the profit-and-loss statements show $600,000 of earnings and the tax returns show $350,000, the lender will underwrite to something much closer to the tax returns.

Add-backs are the other half of this problem. SBA lets the lender adjust cash flow for things like the seller's personal expenses run through the business, but each add-back has to be justified in the lender's credit memo, and add-backs the lender cannot support are thrown out. The owner's salary also has to be enough to cover your own living expenses. A deal priced on a long list of soft add-backs often shrinks once underwriting starts. Our guide to SDE and add-backs shows which ones usually survive.

The Quality Of Earnings Report Finds Problems

When the Business Purchase Price is $3,000,000 or more, the lender also needs a Quality of Earnings report for a first-time purchase. The QoE includes a cash proof, which reconciles the bank statements to the income statement and tax returns, and it documents every add-back and looks at customer concentration and revenue quality.

Here is why it matters: the lender must use the QoE's earnings to test cash flow. If the QoE lowers the earnings, the loan amount is reduced to fit, and more Down Payment has to fill the gap. Typical findings include revenue booked in the wrong period, one customer making up a large share of sales, and owner add-backs that were really business costs. The Quality of Earnings guide explains what the report covers.

The Lease Or The Landlord Stalls

If the business rents its space, the lease can quietly sink the deal. Most lenders want a lease, including renewal options that you control, that runs at least as long as the loan, which on a business purchase is usually 10 years. When a large part of the loan goes to leasehold improvements or fixtures in the space, SBA itself asks for a lease that long, or for a landlord's waiver and an assignment of the lease.

Landlords have no deadline, and a new lease or an assignment can sit on a property manager's desk for weeks. Start the conversation as soon as the LOI is signed, ask the seller to make the introduction, and know what you need: the term, the renewal options and consent to the sale.

The Financing Structure Breaks An SBA Rule

Some deals fail in underwriting because the structure the buyer and seller agreed on is not allowed. The most common ones we see:

• An earnout. SBA prohibits seller earnouts on these loans. A note on full standby or a price inside the valuation usually does the same job. See earnouts and SBA loans.
• A seller who wants to stay on staff. On a first-time purchase, the seller cannot remain an owner, officer or employee. The business can hire the seller as a consultant for up to 24 months in total.
• A seller note that does not really count. Only a note on full standby counts toward the Down Payment. A note on 24-month standby is debt with a payment holiday. The standby note guide explains the difference.
• Total debt above the value. The SBA loan plus any seller note that is not on full standby cannot be more than the business valuation.
• An ineligible owner. Every direct and indirect owner and every required guarantor must be a U.S. citizen or U.S. national living in the U.S.

The Buyer Or The Seller Runs Out Of Patience

Not every failure is technical. Sellers get cold feet when handing over a business they built becomes real, or when diligence requests feel endless. Buyers get cold feet when diligence turns up something they dislike, or when their own cash runs thin. A buyer who planned to bring exactly 5% can run out of room fast when a valuation gap appears.

Two habits help. First, keep momentum: answer document requests within a day or two, and keep a shared list of open items so nobody waits on anybody without knowing it. Second, keep a cushion. Lenders want to see that you have cash left after closing, and a buyer with reserves can absorb a surprise without reopening the price.

How To Keep Your Deal Together

Most of the problems above can be found before you sign the LOI or in its first two weeks. Use this list:

• Get three years of business tax returns before you make an offer
• Compare the listing's earnings to the returns and list every add-back
• Check the price against cash flow at a 1.25 debt service coverage ratio
• Read the lease and note its remaining term and renewal options
• Put any seller note, its standby terms and the consulting period in the LOI
• Confirm there is no earnout and no plan for the seller to stay on staff
• Know where every dollar of your Down Payment is coming from, plus a cushion
• Get a lender's read on the deal before diligence money is spent

That last point is where a pre-qualification letter earns its keep. It tests your numbers against lender rules before the seller takes the business off the market. The due diligence checklist covers the rest of what to review, and the SBA business acquisition loan page covers the product itself.