Seller's Discretionary Earnings: SDE vs EBITDA
What seller's discretionary earnings means, where SDE gives way to adjusted EBITDA, how to recast a tax return step by step, and which add-backs a buyer will accept.
The earnings figure most American small businesses are priced on, where it stops applying, and how to recast a tax return into a number a buyer will accept.
What is seller's discretionary earnings?
the total financial benefit one full-time owner-operator takes from a business in a year
. It is calculated as pre-tax profit plus the owner's full compensation, plus interest, depreciation and amortization, plus documented one-off and personal costs.
Adjusted EBITDA answers a different question. It leaves a market-rate manager's salary in the cost base, because a larger buyer is not going to run the business themselves. That single difference is why the same company can be quoted at a higher multiple of EBITDA and a lower multiple of SDE and be worth exactly the same money. Comparing a multiple without first confirming which earnings figure it applies to is the most common valuation error owners make.
SDE includes", value: "One owner's full compensation and benefits
Recasting means restating the accounts to show what the business earns for its owner, rather than what it reports for tax. Work down the return in this order and document each step as you go.
Start from pre-tax net income on the filed return
Not management accounts, and not a spreadsheet. The filed return is the document a buyer's diligence team will reconcile everything back to, so it is the only sensible starting point.
Debt service belongs to the current owner's financing, not to the business. The buyer will fund the business their own way, so interest comes out of the cost base entirely.
Add back depreciation and amortization
These are accounting charges, not cash. Add them back, then separately establish what the business genuinely needs to spend on replacing vehicles and equipment each year, because a buyer will deduct that figure later whatever the depreciation line says.
Add back one owner's total compensation
Salary, payroll taxes on that salary, distributions taken in place of salary, health insurance, retirement contributions and any vehicle or phone. One owner only. If a spouse or second shareholder also works in the business, their pay stays in the cost base unless the role genuinely disappears on sale.
Add back documented personal expenses
Add back genuinely non-recurring items
A settled legal matter, a one-time system implementation, storm damage not covered by insurance, a single relocation. If a similar item appears in three of the last five years, it is not non-recurring and a diligence team will remove it.
Adjust related-party rent to market, in both directions
If you own the building and charge the company above market rent, add the excess back. If you charge below market, deduct the shortfall. Owners regularly forget the second case and give away earnings they could have claimed.
Deduct anything the buyer will still have to pay
A contractor doing work you have been doing personally, a software contract you have been absorbing, an under-insured liability. Deducting these yourself is better than having them deducted for you at a much later stage.
The figure on the filed return for a single-owner service business with about $3.2M of revenue. On its own it tells a buyer very little about what the business earns.
Plus interest: $28,000: Equipment notes and a line of credit. Removed because the buyer will structure their own financing.
Equipment notes and a line of credit. Removed because the buyer will structure their own financing.
A twelve-vehicle fleet on an accelerated schedule. Added back here, then revisited as a real replacement cost below.
Salary of $140,000, payroll taxes of $16,000, health insurance of $19,000 and a $10,000 retirement contribution, for one working owner.
Plus documented personal costs: $34,000
A personal vehicle at $11,000, family travel at $9,000 and a non-working family member on payroll at $14,000. Itemised, with the entries identifiable in the ledger.
Plus a genuine one-off: $22,000
A single settled employment matter with a closed file behind it. Nothing similar in the four preceding years.
SDE: $675,000: The total benefit available to one working owner. This is the figure an SDE multiple would be applied to for a business of this size.
The total benefit available to one working owner. This is the figure an SDE multiple would be applied to for a business of this size.
SDE less a market-rate general manager at $150,000 including payroll taxes, and less $30,000 of genuine annual fleet replacement above the depreciation charge. This is the figure a platform buyer would work from. The business has not changed; only the question being asked has.
One owner's salary, payroll taxes, insurance and retirement contribution
Personal expenses itemized line by line with ledger references
A one-off legal settlement with a closed file behind it
Related-party rent restated to a supportable market rate
Interest on debt that will not transfer to the buyer
A non-working family member's payroll, identified by name and amount
A single, evidenced, non-repeating project cost
A round-number adjustment labelled owner discretionary spending
A second working owner's salary where the role still has to be filled
Legal or consulting costs that recur in most years
Savings the buyer would make after closing
Revenue you believe you could have won but did not
Depreciation added back with no allowance for real replacement spending
Government relief income left in the trailing twelve months
There is no hard boundary, and buyers differ. These are the patterns we see in the lower middle market rather than a rule.
Owner-managed with a working supervisor, $500K to $1M
Both figures are quoted; buyers differ
Management team in place, earnings above $1M
Private equity platform or strategic buyer
Adjusted EBITDA, whatever the size
Individual buyer using an SBA loan
SDE, because they will run it themselves
The practical consequence is that the same business can be honestly described in two very different ways. If a business is worth $675,000 of SDE at three and a half times, or $495,000 of adjusted EBITDA at just under five times, both descriptions produce roughly the same enterprise value. Never compare a multiple you have been quoted against one you have read somewhere without first checking which of the two it applies to.
What is the difference between SDE and EBITDA?
SDE adds one working owner's entire compensation package back into earnings, on the basis that a single buyer will take over that role and that income. Adjusted EBITDA leaves the cost of a market-rate manager in place, because an institutional buyer will have to employ someone to run the business. For an owner-operated company the gap between the two figures is roughly the cost of replacing yourself.
At what point do buyers switch from SDE to EBITDA?
Around $1M of earnings in most sectors, though it is driven by buyer type more than by any threshold. An individual buyer funding an acquisition with an SBA loan will work in SDE at any size. A private equity platform will work in adjusted EBITDA even for a small bolt-on, because they are adding the business to an existing management structure.
Can I add back my spouse's salary?
Only if the role genuinely disappears when the business is sold. If your spouse runs the office and the buyer will have to hire an office manager, that cost stays in the numbers. If they are on payroll and do not work in the business, it is a documented personal expense and it is a legitimate add-back. Buyers test this specifically, and the answer is usually obvious from the payroll records.
Why do buyers deduct capital expenditure when depreciation was added back?
Because depreciation is a tax calculation and replacement spending is a real cash cost. A business running a fleet of service vehicles has to buy vehicles whether or not the depreciation schedule reflects it. Buyers estimate that maintenance capital expenditure from your own asset register and replacement history, and they deduct it before applying a multiple.
What supporting documents do I need for my add-backs?
Something specific for each line. Invoices for one-off costs, a settlement agreement for a legal matter, payroll records for compensation, a lease and a market comparison for related-party rent, and ledger references for personal expenses. A schedule listing each adjustment with the document behind it is what separates an add-back that holds from one that is removed in review.
Does recasting mean changing my tax return?
No. Recasting is a presentation exercise carried out alongside the filed return, not a restatement of it. The return stays exactly as filed, and the recast schedule shows the bridge from the reported number to the earnings figure a buyer would pay a multiple of. Any recast figure that cannot be traced back to the filed return will be discounted.
How do I find out what my own SDE is?
The free written valuation report rebuilds your earnings the way a buyer will, separates recurring from project revenue, and shows both the SDE and adjusted EBITDA views alongside the factors holding your multiple down. It is free, confidential and commits you to nothing.
Selling a Business in the US
How seller's discretionary earnings and adjusted EBITDA are calculated for a US lower middle market business, and which add-backs buyers accept.
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