When valuing a business, especially in the context of a sale or acquisition, two commonly used financial metrics are SDE (Seller’s Discretionary Earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Understanding the distinction between these two can help clarify how a business's value is determined and which metric is most appropriate for your situation.
What is SDE?
Seller’s Discretionary Earnings (SDE) is a financial metric used primarily for valuing small, owner-operated businesses. It represents the total financial benefit that a full-time owner-operator would derive from the business in a single year.
SDE Formula:
Net Profit + Owner's Salary + Owner Perks (Discretionary Expenses) + Depreciation + Amortization + Interest + One-Time or Non-Recurring Expenses = SDE
SDE assumes the buyer will replace the current owner and run the business themselves. Therefore, only secondary owner salaries are added back, not the primary owner's replacement cost.
What is EBITDA?
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) are more often used for larger businesses or those with layers of management. It represents a business's operating performance without the influence of its capital structure, tax environment, or non-cash expenses.
EBITDA Formula:
Net Profit + Interest + Taxes + Depreciation + Amortization = EBITDA
EBITDA does not include any owner perks or salaries, and instead assumes the buyer will hire someone to operate the business. This makes it a more standardized and scalable measure.
Key Differences
| Feature | SDE | EBITDA |
|---|---|---|
| Commonly Used For | Small businesses | Mid-market and larger companies |
| Assumes Buyer Will | Run the business themselves | Hire a manager to run the business |
| Adds Back Owner Salary | Yes (only for primary owner) | No |
| Adds Back Owner Perks | Yes | No |
| Adds Back One-Time Expenses | Yes | Sometimes, if non-operational |
| Reflects | Total owner benefit | Operational profitability |
Which Metric Should I Use?
- Use SDE if the business is owner-operated, and you (or the buyer) plan to step into that operational role.
- Use EBITDA if the business is managed by a team or if the buyer plans to hire someone else to operate the business.
SDE and EBITDA serve different purposes and target different types of buyers. Choosing the right metric ensures transparency, aligns expectations, and supports a fair valuation.