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Why Seller’s Discretionary Earnings is Used Over EBITDA
Seller’s Discretionary Earnings, commonly abbreviated as SDE, is a financial metric used to determine the true historical benefit to the owner of a small business. It’s a measure of a company’s financial performance that takes into account the owner’s salary, benefits, and other discretionary expenses. At its core, SDE represents the total financial benefit that a single full-time owner-operator would derive from a business on an annual basis. This metric is particularly useful for small to medium-sized businesses, often referred to as “Main Street” businesses, which typically have revenues under $5 million.
The primary reason SDE is favored is that many small businesses don’t report an Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). SDE is essentially adjusted EBITDA plus adjusted compensation for one working owner. Small business owners often manage their finances to minimize net profit—a crucial component of EBITDA—to reduce taxable income. Therefore, SDE provides a more accurate representation of the owner’s benefit stream.
Databases Tracking Seller’s Discretionary Earnings
When valuing small businesses, the databases used typically track SDE rather than EBITDA due to the lack of reported EBITDA. Databases like Bizcomps, ValuSource, and Peercomps exclusively track SDE. While DealStats tracks both SDE and EBITDA, it’s common to find businesses with SDE figures but no EBITDA. This is largely because the owner plays an integral role in the business, and buyers are often essentially “buying a job.”
Variations in Seller’s Discretionary Earnings
Multiples
Based on our observations, SDE multiples can range significantly, typically between 2 to 4 times, depending on the company’s earnings and comparable sales data. These variations hinge on the quality of the company’s earnings and the likelihood of their continuation into the future.

(Source: IBBA)
Comparing SDE and EBITDA Multiples
If an EBITDA figure is available, its multiple will generally be larger because EBITDA excludes the owner’s compensation, whereas SDE includes it. In theory, using either SDE or EBITDA should yield a similar business valuation. For example:
- Using SDE: If SDE is $500,000 with a multiple of 3, the business value is $1,500,000.
- Using EBITDA: Assuming an EBITDA of $300,000 with a multiple of 5.00, the business value is also $1,500,000.
If the valuations derived from SDE and EBITDA don’t align closely, there may be errors in the calculations or in selecting the appropriate multiples.
The Future of SDE in Business Valuation
As the business landscape evolves, so too does the role of SDE:
- Digital Businesses: With the rise of online and digital businesses, SDE calculations may need to adapt to account for different cost structures and revenue models.
- Automation: As businesses become more automated, the concept of owner’s compensation in SDE may need to be reevaluated.
- Data Analytics: Advanced data analytics may allow for more precise and nuanced SDE calculations in the future
Conclusion
Seller’s Discretionary Earnings is more than just a financial metric; it’s a powerful tool for understanding, valuing, and improving small businesses. By mastering the concept of SDE, business owners can make more informed decisions about their company’s future, whether that involves selling, seeking investment, or simply striving for better performance. Remember, while SDE is crucial, it’s just one piece of the puzzle.
A comprehensive business valuation should consider multiple factors, including market conditions, industry trends, and the specific characteristics of the business in question. Whether you’re a seasoned business owner or just starting your entrepreneurial journey, understanding SDE can give you valuable insights into your business’s true financial health and potential.
I hope this insight clarifies the importance of SDE in small business valuation. If you have further questions or would like to discuss this topic in more detail, please feel free to reach out directly.