Seller’s discretionary earnings, explained simply
For a small business, the buyer is often acquiring a job as well as an asset. SDE shows what one owner-operator can take from the business each year, and is the standard earnings measure for businesses without a hired management team.
EBITDA is used for larger businesses where management is paid a market salary within the cost base.
From pre-tax profit to SDE and equivalent EBITDA
IllustrativeRiverbend HVAC Services, $ thousands
Deducting a market salary for a hired manager gives an EBITDA equivalent of $270,000.
Calculation
FormulaSDE = pre-tax profit + owner’s salary and benefits + owner’s personal expenses + interest + depreciation and amortization + one-off items
Worked example
| Riverbend HVAC Services | $ |
|---|---|
| Pre-tax profit | 180,000 |
| Owner’s salary | 120,000 |
| Owner’s personal vehicle and phone | 15,000 |
| Interest | 10,000 |
| Depreciation | 25,000 |
| One-off legal fee | 10,000 |
| SDE | 360,000 |
| Less: market salary for a hired manager | (90,000) |
| Equivalent adjusted EBITDA | 270,000 |
Riverbend HVAC Services is a fictional company. All figures are illustrative.
SDE and EBITDA compared
| SDE | EBITDA | |
|---|---|---|
| Used for | Small owner-operated businesses | Larger businesses with a management team |
| Owner pay | Included in earnings | Deducted at a market salary |
| Typical buyer | Individual, often with an SBA loan | Private equity or a strategic buyer |
Why it matters in a deal
SDE is the starting point for most small business valuations and SBA loan reviews. It also invites generous add-backs, so evidence matters.
Red flags
- More than one owner’s pay added back
- Personal expenses claimed without records
- SDE that does not reconcile to tax returns
Frequently asked questions
What is seller’s discretionary earnings (SDE) in M&A?
Seller’s discretionary earnings is the total financial benefit available to a single full-time owner-operator of a small business: pre-tax profit plus the owner’s compensation and perquisites, interest, depreciation, amortization and one-off items.
When is SDE used instead of EBITDA?
For small businesses where one owner runs operations day to day.
Do lenders use SDE?
Yes. Many SBA lenders review SDE alongside tax returns.