Cathy Hou, CEPA, CMA, CSCA, MBA, PMP
Founder & CEO, CiVER Value Partners
Audit-Proof Your Add-Backs Before the Bank Does
The SBA's new Quality of Earnings rule changes who decides what your shop earns. Here's what it means for aerospace and defense precision machine shop founders planning an exit in the next two to five years.
What changed on October 1, 2026
Under SBA SOP 50 10 8.1, lenders financing qualifying 7(a) deals (initial acquisitions and business expansions with a purchase price of $3 million or more) must now obtain an independent Quality of Earnings (QoE) report. The lender orders it, and the work is performed for the lender's benefit.
That last point matters more than it sounds. A QoE you commissioned to support your asking price does not satisfy the requirement. Neither does one your buyer commissioned. The lender will underwrite to the earnings the independent review supports, not the number in your offering memorandum.
The review also requires a cash proof: a reconciliation of actual cash activity to reported results for the trailing twelve months and the two most recent fiscal years. In plain terms, three years of records that have to tie out to the bank.
The math of a haircut
Say your shop presents $1.0 million in adjusted EBITDA. The independent QoE supports $850,000. That's a 15% haircut.
At the 1.25x minimum debt service coverage the SBA sets for initial acquisitions, the debt service a lender can support falls from $800,000 a year to $680,000. That is $120,000 a year in lost debt capacity.
Over a 10-year SBA amortization, that can translate to roughly $700,000 to $850,000 less a buyer can borrow, depending on rate. What a buyer can borrow shapes what a buyer can pay. The gap rarely gets filled with more buyer equity. It comes out of your price, or comes back to you as risk through earnouts and seller financing.
These figures are illustrative, not a lending quote. The mechanism is real.
Not an SBA deal? This still reaches you.
SBA financing has a ceiling: a single 7(a) loan tops out at $5 million, so the rule bites hardest at the smaller end of the market. If your shop sits in the lower half of the $5M to $30M revenue range, the rule changes who can afford to buy you. Individual buyers, search funds and smaller strategic acquirers often finance with SBA debt, and every one of them now needs earnings that survive an independent review. Fewer of them will clear that bar at your asking price, and a smaller field of qualified bidders means less competition for your shop.
Larger shops will more often sell to private equity platforms assembling precision-machining groups, or to strategic acquirers already in the supply chain. Those buyers have relied on QoE for years, so the SBA rule doesn't change their process. What it does is make the standard universal: at every deal size, the number that counts is the one an independent reviewer can verify.
The add-back storytelling era is ending. Verified earnings are becoming the price of admission.
Where machine shop add-backs break
Experienced reviewers know where the soft numbers usually sit in a machine shop:
• Repairs that are really capital spending. A spindle rebuild or controller retrofit booked as a one-time repair gets tested against your maintenance history. If aging 5-axis equipment needs that work every few years, it's a cost of staying in business, and the reviewer will put it back in.
• Compliance costs called one-time. AS9100 surveillance audits, NADCAP accreditation, ITAR registration and cybersecurity work are recurring costs of defense work. CMMC self-assessment requirements have been in DoD contracts since November 2025, and third-party certification remains on the roadmap even after its rollout was paused for review this summer. A buyer will expect those costs to continue.
• Owner pay that hides a job. If you program, quote and run the floor, removing your salary isn't a clean add-back. The reviewer will subtract what it costs to hire a plant manager and lead programmer in today's machinist labor market.
• Inventory and work in process. Titanium, Inconel and long-lead jobs mean year-end inventory and WIP adjustments can swing EBITDA materially. Without job costing and reconciled counts, the reviewer will discount the number.
• Program revenue that won't repeat. A surge order, or a program that ramped and ended, gets normalized out, along with the overtime and margin that came with it.
Your diligence window is already open
If you plan to exit in two to five years, the financial record you'll be judged on is being written today. Job-cost records, inventory counts and repair invoices can't be rebuilt after the fact. Every unreconciled entry, undocumented owner expense, and "we'll clean it up later" adjustment is becoming part of the permanent file.
Build an internal QoE discipline
The answer isn't a better story. It's a monthly close that would survive scrutiny. Every month, your finance team should deliver:
• A reported-to-adjusted EBITDA bridge. Every adjustment named, quantified, and explained.
• Evidence behind every add-back. Invoices, bank activity, and a clear reason the expense won't continue under new ownership.
• Revenue and margin by customer, program and part family. Concentration in a single prime or Tier 1 is one of the first things a reviewer will test.
• Inventory, WIP, deferred revenue and receivables schedules. Customer deposits and progress billings included, reconciled and tied to the general ledger.
• A repairs-versus-capital log. Every major equipment spend classified when it happens, with the reasoning written down.
• A log of unusual and one-time transactions. Recorded when they happen, not reconstructed during diligence.
This discipline does not replace the independent report. It determines whether the independent report confirms your number or rewrites it.
The one-week test
Could you defend every add-back in your EBITDA bridge, with documented, cash-backed evidence, within one week?
My view: if you can’t produce your EBITDA bridge in a week, you aren’t ready to take calls from buyers. A buyer who asks for it and waits a month is already pricing that delay into the offer.
If the honest answer is "I'm not sure," start with the CiVER Exit Readiness Diagnostic. It's free, takes 15 minutes, and produces a business health and value report showing where your gaps are and a potential enterprise value range. From there, CiVER can run a mock Quality of Earnings review so you see your shop's number the way a lender's reviewer will, before it counts, and our 90-day Exit Lift program prioritizes what to fix first.
SBA SOP 50 10 8.1: https://legacy.sba.gov/document/sop-50-10-lender-development-company-loan-programs
This article is for general information only and is not lending, legal, tax, or investment advice. The SBA QoE requirement applies to qualifying 7(a) loans that receive an SBA loan number on or after October 1, 2026, and the $3 million threshold excludes owner-occupied real estate. Consult your lender and advisors about your specific transaction.
