Divide the cash flow the tax returns support by the yearly payments on all debt that will exist after closing, and compare the result with 1.25x. As of October 2026, SBA SOP 50 10 8.1 tests an Initial Acquisition on historical cash flow only, from the last fiscal year or the average of the last two. Start from net income on the return, add back interest, depreciation, amortization and documented one-time items, then charge a market salary for whoever will run the business. The broker's SDE skips that last step.
Debt service coverage ratio (DSCR) equals cash flow available for debt service divided by total annual debt service. GoSBALoans describes a similar calculation. As of October 2026 the minimum is 1.25x for an Initial Acquisition and an Owner Buyout, and 1.15x for a Business Expansion, per Starfield & Smith.
The bottom of the fraction includes the new SBA loan, any other debt that stays with the business, and seller note payments unless the note is on full standby. A note not on full standby is counted at a maximum 10-year amortization.
Use the business's filed returns for the last fiscal year and the year before. Lenders underwrite from filed returns, so income that never reached a return generally does not count, per GoSBALoans. The usual build is:
Step 6 is the one a listing leaves out. SDE adds back one owner's pay and stops. A lender needs the cost of replacing that work. See What is the difference between SDE and EBITDA? for the difference.
Every figure here is an assumption. An S corporation return shows ordinary business income of $210,000. The notes show officer pay $120,000, depreciation $35,000, interest $15,000 and a documented one-time legal cost of $10,000. The broker also adds $40,000 of personal expenses with no receipts. A manager to replace the owner would cost $90,000.
The broker's figure suggests 1.87x. The return suggests 1.30x. If the lender rejected another $15,000 of add-backs, coverage would fall to 1.24x and the deal would fail.
It is the biggest swing factor. Accredited reports that an owner-compensation adjustment needs written justification in the credit memo and a test against the owner's documented living expenses and personal debt. Bankwell describes the test as business-only, so the business must support itself. The sources differ, so ask your lender which cash flow it will use. Ask what salary figure it assumes.
The lender may use the last fiscal year or the average of the last two. Bankwell gives an illustration where one year reaches 1.18x and fails while the two-year average reaches 1.26x and passes. Ask for both calculations.
For an Initial Acquisition or Business Expansion with a purchase price of $3 million or more, owner-occupied real estate excluded, the lender commissions an independent report and must use its earnings in the coverage test. Add-backs that fail the report reduce your cash flow and your loan. See Which add-backs are legitimate, and which should you question? and Do you need a quality of earnings report to buy a small business?.
Where these numbers come from: Coverage ratios, historical-only testing and the QoE rule are from SBA SOP 50 10 8.1 as summarized by Starfield & Smith, Beancount and Accredited. The tax-return build is a common lender method described by GoSBALoans; your lender may differ. The effective date is in SBA Information Notice 5000-880695. Confirm current terms with an SBA lender.
Lenders generally start from EBITDA-style earnings with the owner's replacement pay charged. As of October 2026, Bankwell describes the test as EBITDA divided by total future debt service.
Some lenders do. In a Searchfunder discussion, one searcher reports that the lenders they spoke with often start from EBITDA and subtract an assumed tax amount. Ask your lender how it treats taxes.
No. Projections can be reviewed but cannot be used to meet the 1.25x test.
When the supported number is lower than the broker's, use it in the offer: The asking price was set under the old SBA rules. How do I use the 1.25x rule to negotiate price?
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