What Is SDE?
SDE โ seller's discretionary earnings โ is the true profit a business owner earns annually. It is the primary metric used to value small businesses selling for under $5 million.
SDE stands for seller's discretionary earnings โ the total financial benefit a business owner receives from the business in a single year. It equals net profit plus the owner's salary, owner benefits, personal expenses run through the business, depreciation, and one-time non-recurring expenses. SDE is the primary valuation metric for small businesses selling under $5 million. A business generating $200,000 in SDE at a 3.0x multiple is worth $600,000.
What SDE Means for Small Business Owners
SDE โ seller's discretionary earnings โ is the total annual financial benefit a small business owner receives from owning and operating the business. It is not the same as net profit, and it is not the same as revenue. SDE is the number that matters most when a buyer is evaluating how much to pay for your business.
The formula is straightforward: SDE equals net profit plus the owner's salary, plus owner benefits, plus personal expenses run through the business, plus depreciation, plus any one-time non-recurring expenses that won't repeat under new ownership. When a buyer looks at your business, they want to know what cash flow they are actually acquiring. SDE is that number. Use YourExitValue's free valuation calculator to see your current SDE and estimated business value.
Why SDE Is Used Instead of Net Profit
Net profit understates the true earning power of a small business because most small business owners pay themselves a salary, run personal expenses through the business, and make discretionary purchases that reduce taxable income but don't reflect the actual cash the business generates. A business with $50,000 net profit and an $80,000 owner salary has $130,000 in real earning power for a buyer who replaces the owner โ not $50,000.
SDE normalizes for these differences, allowing buyers to compare businesses across different ownership structures and compensation approaches on an equal basis. Two businesses generating $500,000 in revenue but paying the owner differently will have similar SDE if the underlying operations are equivalent.
What Add-Backs Are Included in SDE
Add-backs are the expenses that increase net profit to arrive at SDE. Common add-backs include the owner's total compensation โ salary, health insurance, retirement contributions, auto allowance โ personal travel or meals run through the business, depreciation on assets the buyer may not replace, one-time professional fees like litigation costs unlikely to recur, and excess rent paid to a related party above market rate.
Buyers scrutinize add-backs carefully during due diligence. Every add-back must be defensible with documentation. Add-backs that cannot be verified with bank statements or tax returns are challenged or excluded from the SDE calculation โ directly reducing the valuation basis.
How SDE Relates to Business Value
Business value is calculated by multiplying SDE by an industry-appropriate multiple. A carpet cleaning business at 2.5x SDE, an HVAC business at 3.5x SDE, and a pest control business at 4.0x SDE all use SDE as the baseline โ the multiple applied reflects the quality and predictability of that cash flow. Understanding your SDE is step one in knowing what your business is actually worth.
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Key Takeaways
- โฆSDE equals net profit plus owner salary, owner benefits, personal expenses, depreciation, and non-recurring expenses
- โฆ - SDE is the primary valuation metric for businesses selling under $5 million
- โฆ - Net profit understates true business earning power because owner compensation and personal expenses are excluded
- โฆ - Business value equals SDE multiplied by an industry-appropriate multiple
- โฆ - All add-backs must be defensible with documentation โ unverified add-backs are challenged by buyers
Frequently Asked Questions
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