SDE vs EBITDA: which earnings number do buyers use?
The difference between seller's discretionary earnings and EBITDA, when each one applies, and how to work out yours from your accounts.
SDE and EBITDA are two ways of answering the same question: how much does this business really earn? The difference is how each one treats the owner.
What each one means
Seller's discretionary earnings (SDE) is the total financial benefit one full-time owner takes from the business. Start with profit before tax and add back interest, depreciation, amortization, the owner's salary and benefits, and expenses that are one-off or personal.
EBITDA is earnings before interest, tax, depreciation and amortization. In a sale, buyers use adjusted EBITDA: they remove one-off items and replace the owner's actual pay with what it would cost to hire someone to do the owner's job.
From one to the other
The two numbers are linked by one line: a market-rate salary for the owner's role.
| Amount | |
|---|---|
| Profit before tax | $180,000 |
| Add: interest and depreciation | $30,000 |
| Add: owner's salary and benefits | $90,000 |
| Add: one-off and personal expenses | $10,000 |
| SDE | $310,000 |
| Less: market salary for a manager | ($110,000) |
| Adjusted EBITDA | $200,000 |
Same business, two very different earnings figures. That is why a multiple only means something when you know which earnings it is applied to. A business priced at 2.6 times SDE and one priced at 4 times EBITDA can be the same price.
Which one applies to you
- SDE is the norm for owner-operated businesses, typically those earning under about $1 million a year for the owner. The usual buyer is an individual who will work in the business.
- EBITDA is the norm for larger businesses with a management team. The usual buyers are companies and investors who will not work in the business day to day.
There is no hard line between the two. Businesses in the middle are often looked at both ways.
What counts as an add-back
Add-backs are where most disagreements with buyers happen. A buyer will accept an add-back only if it is real, documented and will not recur.
Usually accepted:
- Owner's salary, payroll taxes and benefits (for SDE)
- Interest, depreciation and amortization
- One-off costs such as a lawsuit, a move or storm damage
- Personal expenses paid by the business, where you can show the receipts
Usually challenged:
- "One-off" costs that happen most years
- Family members on the payroll who do real work that someone would need to be paid for
- Cash sales that are not in the books
- Cutting marketing or maintenance to flatter the latest year
Common mistakes
- Adding back the owner's salary twice. If you take dividends instead of a salary, there may be no salary in the accounts to add back.
- Mixing the measures. Applying an EBITDA multiple to SDE overstates value, often by a wide margin.
- Ignoring a second owner. SDE assumes one full-time owner. If two owners work in the business, one salary is a real cost and stays in.
- Forgetting equipment replacement. Depreciation is added back, but vans and machines still wear out. Buyers adjust for the spending needed to keep the business running.
Common questions
Is a higher add-back total always better?
No. A long list of aggressive add-backs makes buyers doubt the whole set of numbers. A short, well-documented list is worth more than a long, shaky one.
Which years do buyers look at?
Usually the last three full years and the most recent twelve months. They weight recent periods more heavily and look hard at the trend.
Can I work out SDE from my tax return?
Roughly, yes. Start with taxable income and add back the same items. Management accounts are usually more reliable because tax returns are prepared to minimize tax, not to show earning power.