The Bank Approved It. That Is Not A Second Opinion.

There is a version of this deal where the bank collects every dollar it is owed, on time, for ten straight years, and you make almost nothing.

It is not the disaster scenario. It is not fraud, or a hidden liability, or a customer walking. It is the ordinary case. The business performs roughly the way the listing said it would, the payments clear, the lender's file stays clean, and at the end of the year you look at what landed in your account and wonder what happened.

That gap is where most first-time buyers get hurt, and the approval letter is what walks them into it.

Who The Approval Letter Actually Protects

When a lender approves your acquisition loan, he has answered exactly one question: can this business service this debt. That is it. He has not asked whether the price is fair. He has not asked whether you will earn a living. He has not asked what happens to you if revenue slips a fifth.

And the bar he clears it against is low. Lenders underwrite acquisitions to a 1.25x coverage floor, and the SBA rulebook taking effect October 1 writes that number into the program itself. It is a fraction of what I want to see before I would put my own money into a business. On a 7(a) loan above $150,000, the SBA guarantees up to 75 percent of what the lender put out. So his real exposure is a quarter of the loan, and he is holding your personal guarantee against that quarter.

Then look at what changed on the collateral side. The threshold that used to sit at $500,000 came down to $50,000, which means on almost any acquisition loan the lender is now expected to take the collateral that is available. For most buyers, the collateral that is available is the equity in their house.

Add it up. He is covered on three quarters of the loan by the government, secured on the rest by your home, and satisfied at 1.25x. Of course he approved it.

Your lender is not on your side of the table. He is not against you either. He is just sitting at a different table, answering a different question, and he was never asked yours.

The bank is underwriting its downside. Nobody is underwriting yours.

What Lives Between 1.25x And 2.0x

Run one. Commercial business, asking $1,800,000, cash flow of $400,000. Standard structure: 80 percent SBA, 10 percent seller note, 10 percent down.

Your SBA piece is $1,440,000. At 10.5 percent over ten years, that is about $19,400 a month, call it $233,000 a year. Your seller note is $180,000 at 5 percent interest only, another $9,000. Total debt service, roughly $242,000.

Coverage comes to 1.65x. That is not a marginal file. That sails through underwriting with room to spare, and the buyer who receives that approval letter feels validated by it.

Now finish the math the lender never ran. Your cash flow is $400,000 and your debt service is $242,000, so $158,000 is left. Somebody has to run the business. If that somebody is a general manager at market rate, call it $75,000, and you keep about $83,000. If that somebody is you, then $75,000 of what you keep is wages for a job, and the return on your money is the $83,000.

Then take the ordinary bad year. Revenue slips 20 percent, cash flow lands at $320,000. Your debt service does not move. It is still $242,000. You are left with $78,000, the manager still costs $75,000, and your entire year of ownership nets out around three thousand dollars.

And here is the part that should bother you. Coverage in that year is still 1.32x, so the deal clears the lender's 1.25x floor even in the bad year. Every coverage test the bank would ever apply to this file passes. And the owner takes home about three thousand dollars.

I worked with a buyer last year who had an approval letter on a deal shaped almost exactly like that one, and he told me the bank had done the diligence for him. That sentence is the whole problem in nine words. He had a financing document and he was reading it as a valuation opinion.

Read The Letter For What It Says

After 35 years of looking at these, here is the discipline that keeps buyers out of the gap.

Take the coverage ratio the lender calculated and treat it as the starting point, not the answer. Then cut the cash flow by 20 percent and run it again. Anything under 1.25x on that stressed number is dead on arrival and I do not finish reading it. But do not mistake 1.25x for a passing grade. It is the bank's number, it is the line where the conversation stops, and it is far too tight to buy on. I want 2.0x after the haircut. That is the difference between a bad year being a bad year and a bad year being an emergency, and a deal that clears at 1.65x today and 1.32x under stress is a deal where the bank is fine and you are the shock absorber.

Then subtract a market-rate manager salary before you decide what the business earns. Not because you plan to hire one. Because if the number only works when you supply free labor, you did not buy a business, and the day you get sick you will find out what you actually bought.

Then read the guarantee and the collateral schedule with the same attention you gave the financials. If your house is pledged, that belongs in your thinking about the price, because the downside is no longer capped at your down payment.

You can put a deal through all three of those tests in about a minute. Run it through DealScore Pro and watch what the stressed number does to a deal your lender already blessed. The two answers are frequently not the same answer, and that difference is the entire reason the criteria exist.

An approval letter tells you a deal is financeable. It does not tell you a deal is good.

What This Means For You

If you have an approval letter in hand right now, take the cash flow the lender used, cut it by 20 percent, subtract what it would cost to pay somebody else to run the business, and look at what is left. That number is your answer, and the letter never contained it.

The coverage floor, the stress test, the manager salary, the whole set of criteria I run before I look at anybody's approval letter, is in the free 28-minute masterclass. Watch the free masterclass here.

Mike

Forward this email. Tell them to grab Mike's free book - Real Estate Is for Suckers: Buy a Business Instead. Same framework Mike uses to stress-test every deal.