Glossary
Seller's Discretionary Earnings (SDE)
Seller's discretionary earnings (SDE) is a measure of small business cash flow that adds the owner's salary, personal benefits, interest, depreciation, amortization and non-recurring expenses back to pre-tax profit. It represents the total financial benefit available to one full-time owner-operator and is the standard earnings base for valuing small businesses.
Formula
Example
A small HVAC company reports pre-tax net income of $180,000. The owner draws a $90,000 salary and runs $15,000 of personal vehicle and health insurance costs through the business. Interest is $10,000, depreciation is $25,000 and a one-time legal settlement cost $20,000. SDE = $180,000 + $90,000 + $15,000 + $10,000 + $25,000 + $20,000 = $340,000. At a 2.75x multiple, the implied business value is $935,000.
How it is used in underwriting
Business brokers, buyers and SBA lenders rely on SDE for owner-operated companies, typically those with a few million dollars of revenue or less, where one owner does the core work and the financial statements mix business and personal expenses. Underwriters rebuild SDE from tax returns, since those are harder to inflate than internal statements, and require support for every add-back. Lenders then subtract a reasonable salary for the buyer, or confirm the buyer can live on what remains after debt service, to test whether the business can service the acquisition loan and still support the new owner.
The most common SDE problem is unsupported add-backs. Personal expenses should appear clearly in the general ledger, and non-recurring items must truly be one-time; a lawsuit every year is a cost of doing business. SDE counts only one owner's compensation, so if two owners work full time, the second salary should stay as an expense. SDE differs from EBITDA, which deducts a market salary for management and is used for larger companies run by professional managers. Applying an EBITDA multiple to SDE, or the reverse, materially misprices the business.
Typical benchmarks
Owner-operated businesses with SDE below roughly $1,000,000 often trade around 2x to 4x SDE, depending on industry, growth, customer concentration and owner dependence. Larger companies are usually valued on EBITDA instead.
Run the numbers: Small Business Valuation Calculator (SDE)
Frequently asked questions
What is the difference between SDE and EBITDA?
SDE adds back the full compensation of one owner-operator, while EBITDA deducts a market-rate salary for management. SDE suits small owner-run businesses; EBITDA suits larger companies with professional managers. For the same business, SDE is higher than EBITDA by roughly the cost of replacing the owner.
What add-backs are allowed in SDE?
Common add-backs include one owner's salary and payroll taxes, owner health insurance, personal vehicle and travel costs run through the business, interest, depreciation, amortization and truly non-recurring expenses. Every add-back should be documented in the general ledger or tax return. Lenders and buyers routinely reject add-backs that cannot be supported.
How many times SDE do small businesses sell for?
Many small owner-operated businesses sell for roughly 2x to 4x SDE. Businesses with recurring revenue, diversified customers, documented processes and limited owner involvement tend to earn higher multiples, while those dependent on the owner or a few customers tend to sell for less.
Related terms
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