SBA financing rules out the earn-out

A business purchase financed with an SBA 7(a) loan carries a purchase price fixed at closing. Contingent consideration tied to post-closing performance, whether called an earn-out, a revenue share, or a profit participation, does not fit. Stated as of September 2026; confirm the edition governing your loan. The gap gets bridged with price, a seller note, and diligence instead.

Can I use an earn-out if my acquisition is financed with an SBA 7(a) loan?

No. A 7(a)-financed change of ownership is underwritten against a purchase price that is fixed and determinable at closing, so a price that moves with next year’s revenue, gross profit, or EBITDA does not fit. That is the position as of September 2026, under the operating procedure then in force. Ask your lender which edition governs yours.

An earn-out means part of the price is paid later, and only if the business hits agreed numbers after closing. That is contingent consideration. The loan is sized, underwritten, and authorized against a number, and that number has to be knowable the day the loan funds.

Two sources of authority sit behind this and they do different work. The regulation permits the purchase: 7(a) proceeds may buy all or part of an owner’s interest, or all or part of a business. It says nothing about how the price is structured. A companion regulation restricts uses of proceeds and carves out payments that facilitate a change of ownership. The pricing condition comes from the operating procedure, SOP 50 10, and from how the lender applies it. That procedure is revised, and the edition in force when the SBA loan number issues governs.

Rule: 13 C.F.R. 120.202, Loans for changes of ownership (as revised at 88 Fed. Reg. 21086, Apr. 10, 2023).

Rule: 13 C.F.R. 120.130(a), Restrictions on uses of proceeds.

Policy: SBA SOP 50 10 8, effective June 1, 2025, announced by SBA Information Notice 5000-866746 (Apr. 21, 2025).

Policy: SBA SOP 50 10 8.1, effective October 1, 2026, announced by SBA Information Notice 5000-880695 (Aug. 14, 2026).

Treat this as the condition your lender enforces, not a pinpoint you can wave at a seller. Ask for the change-of-ownership section of the edition it applies and read it yourself. Sign a letter of intent in late September 2026 and close in the fall, and the newer edition may govern, because the rule follows the loan number, not the application date.

Do not try to dress the term up either. A consulting fee that scales with revenue, a bonus keyed to retained customers, a second closing payment triggered by a profit target: all of it is the price moving with performance. Expect the lender, or its closing counsel, to read the purchase agreement before funding, and to require the term out at your expense.

Why does losing the earn-out hurt the buyer more than the seller?

The earn-out is mainly the buyer’s tool. It is how a buyer declines to pay today for performance the seller has only projected. Remove it and the buyer has to agree one fixed number now, on the evidence available, or walk away. That asymmetry is the real cost of the rule.

The seller holds the history: the customer concentration, the add-backs, the reason the top salesperson left in March. The projection costs the seller nothing to make. You fund it with borrowed money, and you sign the guaranty.

With an earn-out, the disagreement about the future gets resolved by the future. In a 7(a) deal, it has to be resolved by you, in advance, with evidence. No post-closing true-up is waiting to rescue a price you were not sure about. Under the edition effective October 1, 2026, the coverage test on a first acquisition runs on historical results rather than projections, which closes another place optimism used to sit.

An earn-out is how a buyer says “prove it.” On a 7(a)-financed purchase you have to say it before the letter of intent, because afterward there is no place left to put the word.

The consequence is a sequencing change, not a drafting change. Your diligence has to move in front of the price. Work done after the price is agreed can only be used to retrade, and retrading costs goodwill and leverage.

Everyone says earn-outs are standard in M&A. Why does that not apply here?

Earn-out frequency figures come from a different population of deals: negotiated between institutions, funded with committed equity or non-program debt, with no federal operating procedure attached to the money. A 7(a)-financed purchase carries that procedure as a condition of funding, and a program condition is not a negotiating position.

The differences run deeper than size. There the buyer is an entity with capital already raised and no personal guaranty. Representation and warranty insurance is ordinary there and uncommon on a purchase of this kind, so do not build a structure that assumes it. Nobody has to clear the terms with a credit officer.

None of that is your situation. When a broker or a seller’s attorney sends a template with an earn-out schedule attached, the correct read is not “this is market.” It is that the form came from a different market. Strike it.

What can I use instead of an earn-out to bridge the valuation gap?

Five tools remain: a lower fixed price supported by earnings work, a seller note the buyer can reach by setoff, a seller note whose principal can be forgiven downward if agreed conditions fail, a holdback or escrow the lender approves, and diligence done before the letter of intent. Walking away stays available throughout.

The equity injection sits underneath all of this. A complete change of ownership requires a minimum injection of ten percent of total project cost, so every dollar added to the price adds to the cash you personally produce as well as to the debt. Stated as of September 2026. The coming edition tightens which sources can fill that injection, including standby seller debt, so ask what your lender will accept.

Policy: SBA SOP 50 10 8, change of ownership and equity injection, effective June 1, 2025; SOP 50 10 8.1, changes of ownership, effective October 1, 2026.

How does a seller note do the work an earn-out used to do?

A seller note is a promissory note from the buyer to the seller for part of the price. It keeps the price fixed while leaving money in the seller’s hands you can still reach. Negotiate an express setoff right and the buyer reduces principal instead of chasing a seller already paid in full.

There are two versions of the note and they are not the same instrument. A note credited toward your required equity injection has to sit on full standby for the life of the loan, meaning no principal and no interest during that period, and it can supply no more than half of the injection. A note outside the injection is ordinary subordinated debt on whatever standby and subordination terms the lender requires. That is the position as of September 2026, and the October 1, 2026 edition revisits it, so confirm before you price the note.

Lenders commonly use SBA Form 155 for the standby; some use their own form carrying the terms SBA requires. A standby is not a lien subordination, so a separate subordination agreement is typical.

Form: SBA Form 155, Standby Agreement.

I read the lender’s term sheet and the standby agreement before I mark up the note, because the note cannot promise the seller anything the standby forbids.

Now the part that cuts against you. A seller who cannot receive principal or interest until the 7(a) loan is repaid, commonly ten years on the business portion, discounts that paper heavily and prices the discount back into the deal. He asks for a bigger face amount, a higher headline price, or both. The standby that protects your lender makes your cheapest money expensive to negotiate.

Setoff also has to be drafted twice. The right belongs in the purchase agreement, as a remedy for breach of the representations, and in the note, as an express exception to the promise to pay. Leave it out of the note and the seller sues on the note while your indemnity claim runs separately. Two lawsuits, one problem. Draft it so exercising it does not breach the standby, and expect the seller to contest the amount.

A setoff right is worth exactly as much as the note principal still outstanding when the problem surfaces. Set the note’s term against the time it takes for a hidden problem to show itself.

What happens if an earn-out is still in the letter of intent?

A contingent price term that survives into the letter of intent has to be unwound later, usually when credit review or closing counsel reads the draft purchase agreement. That correction lands badly. The seller has been off market for weeks, you have spent money on diligence, and the change reads to the seller as a price cut.

Your leverage is at its lowest exactly then, and the seller’s grievance at its highest. Nothing about that conversation improves because the term sat in the document for two months.

So read the financing constraint before you sign, not after. And read which paragraphs of that letter bind you. Price is usually non-binding, while exclusivity, confidentiality, and expense provisions usually are binding, but the operative language controls, not the label at the top. A non-binding number still sets the anchor every later conversation drags against.

What should you do before you sign the letter of intent?

Strike contingent pricing from the letter of intent and reallocate the gap in the same draft. Say how much comes off the price, how much sits in a seller note, and how much sits in escrow. A named gap can be negotiated. A gap parked in an earn-out gets reopened later, under worse conditions.

• Ask your lender, in writing, which SOP edition will govern and how that lender treats contingent consideration.
• Delete earn-out, revenue share, profit participation, and performance bonus language. Replace it with one number.
• Ask whether a quality-of-earnings report is required, who must order it, and what happens if the valuation lands under the price.
• Propose the seller note in the letter of intent, with its face amount, term, and an express right of setoff. Ask what portion, if any, counts toward your equity injection and on what standby terms.
• Ask, before drafting, whether the lender accepts a seller note with downward-only forgiveness, and raise any holdback or escrow then.
• Confirm how long and in what capacity the seller may stay involved after closing under the edition in force.
• Mark which paragraphs of the letter bind you, and read the exclusivity period against your diligence calendar.
• Write down your walk-away number before diligence starts, and keep it where you can see it.

One last piece of housekeeping. This states the position as of September 2026, when SOP 50 10 8 governs and SOP 50 10 8.1 takes effect on October 1, 2026 for loans numbered on or after that date. The SOP is revised. Confirm the current edition, and the section your lender applies, before you rely on any of it. The credit decision and the closing date belong to the lender and to SBA.