SDE vs EBITDA, and why using the wrong one costs you money

What is SDE?

Seller's discretionary earnings is the total financial benefit one owner-operator takes from a business in a year. You start with net profit from the tax return and add back the owner's salary, the owner's personal expenses run through the business, one-off costs that will not recur, and interest, depreciation and amortisation. The result answers the question a small business buyer is really asking: if I run this myself, how much does it put in my pocket?

What is EBITDA?

EBITDA is earnings before interest, taxes, depreciation and amortisation, and it does not add back an owner's salary. It assumes the business pays a market-rate manager to do the owner's job, and treats that cost as a real expense. That makes EBITDA the right measure once a business is genuinely run by staff rather than by its owner, because it shows what the business earns as an asset rather than as a job.

What is the actual difference between them?

One owner's salary, plus that owner's personal expenses. For a business where the owner pays themselves $120,000, SDE is roughly $120,000 higher than EBITDA before any other adjustment. That is not a rounding difference. At a 3x multiple it moves the valuation by $360,000, which is why the two numbers are never interchangeable.

Which one should you use?

Use SDE for owner-operated businesses, and EBITDA once earnings pass roughly $1 million with management in place. The rough dividing lines buyers and brokers actually apply:

• Owner works in the business daily, earnings under about $1 million: SDE
• Management team runs it, owner is an absentee investor: EBITDA
• Earnings above roughly $1 million to $2 million: EBITDA, because that is what acquirers at that size use
• Any business being compared to another: whichever one both sides are using, consistently

Why do the multiples differ?

SDE multiples are lower than EBITDA multiples because SDE is a larger number describing the same business. Small owner-operated businesses commonly trade at 2 to 4 times SDE. Larger businesses valued on EBITDA trade at higher multiples, often 4 to 7 times or more, partly because they are less dependent on any one person and partly because more buyers can finance them. Applying an EBITDA multiple to an SDE figure produces a number no buyer will pay, and it is the single most common self-inflicted mistake in small business valuation.

Which add-backs will a buyer actually accept?

The ones you can prove with a document, and no others. Every add-back you claim increases the price you are asking for, so every one gets challenged. A car lease with an invoice, a one-time legal settlement with a filing, a family member on payroll who does not work there: all defensible with paperwork. A vague $40,000 of miscellaneous personal spending is not, and claiming it damages your credibility on the add-backs that were real.

How do you check someone else's SDE?

Work backwards from the tax return, never forwards from the seller's spreadsheet. Start with the filed return, which is the number the seller told the government. Add back each claimed adjustment one at a time, asking for the document behind it. Then compare the resulting revenue to twelve months of bank statements. If the three do not reconcile, the gap is the thing to understand before you discuss price.