Quick answer: Seller’s discretionary earnings, or SDE, shows the total benefit one full-time owner-operator receives from a business, including the owner’s pay. EBITDA shows the operating profit after paying a market-rate manager to do the owner’s job. SDE fits small businesses sold to individual buyers who will work in them. EBITDA fits larger businesses that need management and attract institutional buyers.
Key points
SDE and EBITDA are not interchangeable. Multiples quoted for one cannot be applied to the other.
The difference is the treatment of the owner. SDE adds back the owner’s compensation and benefits. EBITDA charges the business with the market cost of someone to replace the owner.
Definitions of SDE vary by source, so confirm exactly what is included before comparing figures.
As a company grows and the owner steps back, buyers shift from SDE-based pricing to EBITDA-based pricing, and the multiple and the buyer pool change with it.
Two ways of measuring the same business
When a business is sold, buyers want a single number that shows the earning power they are acquiring. Two measures dominate. They start from the same financial statements and usually end up at different numbers, because they answer different questions about the owner.
Seller’s discretionary earnings (SDE) answers: how much does one full-time owner-operator earn from this business in total? It is the profit available to a person who will both run the business and keep the profit.
EBITDA answers: how much profit does the business earn after paying someone to do everything the owner does? It treats the owner’s job as a cost, the same as any other employee’s.
How each is calculated
SDE usually starts with pre-tax earnings and adds back interest, depreciation and amortization, one-time or non-recurring expenses, and the compensation and benefits of a single owner-operator, including payroll taxes and perks. Definitions vary among brokers, lenders and valuation firms, so it is wise to confirm what a given figure includes.
EBITDA starts with net income and adds back interest, income taxes, depreciation and amortization. The owner’s compensation is not added back in full. It is replaced with what the business would have to pay to hire a competent manager, so only the excess over that market cost is added back. The guide to EBITDA add-backs explains the other adjustments.
Illustrative example: The same business under both measures
A small company reports net income of $300,000. The owner is paid $200,000, the company paid $20,000 of interest and $50,000 of depreciation, and it booked a one-time $30,000 expense. There is no income tax because it is a pass-through entity. SDE is $300,000 plus $200,000 plus $20,000 plus $50,000 plus $30,000, which equals $600,000. A general manager to replace the owner would cost $150,000. EBITDA adjusted for a market-rate manager is therefore $600,000 minus $150,000, which equals $450,000. The numbers are invented to show the difference and are not a benchmark.
Why the difference matters to price
A buyer uses the measure that matches how the business will be run. An individual who buys a small business plans to work in it every day. The business needs to support that person’s income and the payments on any loan they take. SDE describes that pool of income, and buyers price on a multiple of it.
An institutional buyer or a larger operating company does not plan to do the owner’s job. It will hire a manager, so it treats management as a cost and prices on EBITDA, usually a larger number with a different multiple and a different financing structure.
Mixing the measures causes errors. If an owner hears that businesses like theirs sell for a certain multiple of SDE and applies it to EBITDA, the answer will be wrong in one direction, and applying an EBITDA multiple to SDE will be wrong in the other. The explanation of valuation multiples describes why multiples have to be matched to the measure they were derived from.
Which one applies to your business
Several factors point toward one measure or the other.
FactorPoints toward SDEPoints toward EBITDAOwner’s roleWorks full time in daily operationsManages through a leadership teamManagement depthFew or no senior employeesA team that can run the businessLikely buyerAn individual who will operate itA company or investorFinancingOften an SBA-type loan or seller financingOften bank debt and equity from an institutionBusiness sizeSmaller, owner-operatedLarger, with layers of management
Many businesses sit in between. An owner who has built a management team but still handles key customers and decisions may attract both kinds of buyer, and the analysis should show value both ways. The guide to key-person risk explains how owner dependence shifts buyers’ views.
What happens as a business grows
Growth changes the measure. As a company adds managers and the owner works less in operations, the business looks less like a job and more like an asset. A buyer’s attention moves from what the owner takes home to what the business earns after management. That is when institutional buyers begin to pay attention, and EBITDA becomes the standard.
The shift is also a shift in the kind of advisor that fits. The comparison of M&A advisors and business brokers describes how the intermediaries that serve each end of the market differ.
If you are not sure where your business sits, a transactional valuation can show how buyers of each type would measure and price the business.
Frequently asked questions
Is SDE higher than EBITDA?
Usually, because SDE adds back the owner’s whole compensation and EBITDA only adds back the amount above a market replacement. The difference equals the market cost of the manager or managers needed to do the owner’s job, together with differences in how the two measures treat benefits and discretionary items.
Can I convert an SDE multiple to an EBITDA multiple?
Not by simple arithmetic. SDE multiples describe what individual buyers pay for earnings that include their own salary, and EBITDA multiples describe what buyers pay for earnings after management costs. The buyers, the risk and the financing differ, so the multiples are not equivalent.
Which measure should I use if I am unsure?
Ask who is most likely to buy. If the likely buyer is an individual who will run the business and replace the owner’s role, SDE is common. If the likely buyer is a company or investor that will hire management, EBITDA is the measure they will use.
Do buyers accept my SDE calculation as presented?
Buyers test it. They check that the owner’s compensation is actually discretionary, that the discretionary items are real and documented, and that the business can support a buyer’s living and debt payments.
Thinking about a sale or an acquisition?
The Impetus Group provides sell-side and buy-side M&A advisory, from preparation and buyer outreach to negotiation and closing. A transactional valuation is often the first step, scoped and priced separately.
Related guides
EBITDA Add-Backs: What Buyers Accept and What They Reject: Learn which EBITDA add-backs buyers accept in a sale, which they reject, and how adjusted EBITDA changes enterprise value, with a worked illustration.
M&A Advisor vs. Business Broker: Which Fits Your Business?: M&A advisors and business brokers both help sell companies, but they usually serve different sizes of business and buyers. Compare the two and see which fits.
Valuation Multiples Explained: EV/EBITDA, EV/Revenue and More: What valuation multiples are, how EV/EBITDA, EV/revenue and EV/EBIT work, what drives a higher or lower multiple, and how to use public data with care.
Key-Person Risk: How Owner Dependence Affects Valuation: How buyers measure owner dependence, why it lowers value and shapes deal structure, and what an owner can change in the years before a sale to reduce it.
Transactional Valuation vs. Appraisal: Which Do You Need?: A transactional valuation estimates what a buyer would pay. An appraisal estimates value under a legal or tax standard. See how they differ and which one fits.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.