SBA deal structuring — passing the DSCR test without giving away the note.

The DSCR constraint is binary. If the agency's cash flow cannot cover the debt service by 1.15x–1.25x, the bank rejects the loan regardless of buyer intent or agency quality. The price cannot simply be reduced because the buyer needs the full book to generate the revenue that supports the loan. The structure has to change.

§ 01 · The DSCR deal-killerThe math the bank actually runs.

The formula is simple. Cash Flow / Total Debt Service must be at least 1.15x. The total debt service includes both the bank loan payments and any seller-note payments. If the ratio is tight — say 1.08x — the bank will not approve. The deal does not get done at that structure, even if both parties want it.

Two sources of variance matter. Cash flow is the bank's calculation of normalized EBITDA — they will scrutinize adjustments. Debt service includes any seller note payments unless those are explicitly removed from the calculation through a standby provision. Most SBA bank deal failures trace to one of these two inputs being wrong at the time of underwriting.

§ 02 · 24-Month Full StandbyThe primary tool for passing the test.

Placing the seller note on Full Standby — no principal or interest payments for the first 24 months post-closing — removes the seller note from the monthly debt service calculation. The SBA lender underwrites only against the bank loan payments. The DSCR improves immediately, often by a meaningful margin.

The trade-offs for the seller are negotiable. Interest rate step-up. Increase the rate to 7% or Prime + 2% after the standby period ends, compensating for the delayed cash flow. Interest accrual. Ensure interest accrues during the standby period, increasing the total payout when payments resume. Retention-based earnout at month 24. Tie an earnout measurement to the 24-month mark, aligning the standby end with a performance validation.

A negotiation framing that works: "I understand SBA requires subordination. I'm prepared to put the note on full standby for 24 months to help you pass the DSCR test. In exchange, I'd like the interest rate to step up to 7% after the standby period and for the retention-based earnout to be measured at month 24."

§ 03 · Other DSCR leversWhen standby alone is not enough.

When the DSCR is tight but close, additional levers help. Amortization extension. Extend the seller-note amortization from 7 to 10 years, reducing monthly payments. Consulting-agreement shift. Move a portion of the purchase price into a consulting agreement, which hits the P&L differently than debt service. Earnout deferral. Shift contingent payments to later years, reducing debt service in the early measurement period.

Each lever has a cost. Longer amortization extends the seller's credit exposure. Consulting-agreement allocation is ordinary income (taxed up to 37%) rather than capital gains (~20%). Earnout deferral delays cash. None are free; all are negotiable against the deal structure as a whole.

§ 04 · Note Bifurcation for SBA complianceSplitting the instrument.

For SBA 7(a) transactions, the SBA has strict equity-injection rules. The buyer must contribute meaningful equity to the deal. The optimal structure splits the seller note into two distinct instruments.

Standby Note (maximum 5% of deal value). Full standby — no principal or interest payments at all. This counts as the buyer's SBA-required equity injection. It's not equity in the legal sense, but the SBA treats it as such for underwriting purposes.

Servicing Note (the balance). Monthly principal and interest payments, providing the seller with ongoing cash flow. This is the seller's real income stream.

The bifurcation satisfies two competing needs simultaneously — the SBA's equity-injection requirement (standby note) and the seller's desire for cash flow (servicing note). Without the split, the seller often ends up with one large standby note that satisfies SBA but kills cash flow, or one large servicing note that the bank cannot approve.

§ 05 · The headline-multiple ceilingWhat individual-buyer math allows.

SBA 7(a) caps loans at $5M. That ceiling, combined with the DSCR constraint, limits what an individual buyer can pay. In practice, well-prepared books trading at the upper edge of the market band (8–10× per the readiness model) typically clear that band via strategic or PE-backed buyers; individual buyers reach into the lower edge of the market band or remain in the distressed-or-internal range (4–6×) unless they bring meaningful additional equity. Sellers running a process should know which band their book is targeting and which buyer pool that targets. The standby/bifurcation engineering above is what makes the individual-buyer path work within its constraints — not what makes it competitive against PE.

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