SDE and EBITDA Are Not the Same Number

Seller's discretionary earnings (SDE) and EBITDA both measure a business's earning power, but they answer different questions. SDE shows the total financial benefit the business provides to one owner-operator. EBITDA shows what the business earns after paying market-rate compensation for someone to run it. Because the two figures differ, a valuation multiple built on one cannot be applied to the other. Smaller owner-operated businesses are usually valued on SDE, and larger businesses with management teams are usually valued on EBITDA.

What SDE measures

SDE starts with the business's pre-tax profit and adds back:

• One owner's total compensation and benefits
• Interest expense
• Depreciation and amortization
• Discretionary or personal expenses run through the business
• One-time, non-recurring expenses

The result answers the question an owner-operator buyer is asking: how much money does this business produce for the person who runs it, before debt service?

What EBITDA measures

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. In a business sale, it is usually adjusted for discretionary and one-time items, just as SDE is. The key difference is owner compensation. EBITDA treats a market-rate salary for the owner's role as an expense.

The result answers the question a private equity firm or strategic acquirer is asking: how much does this business earn after paying someone to manage it?

A simple illustration

Consider a hypothetical business with these figures:

• Pre-tax profit: $150,000
• Owner's salary and benefits: $120,000
• Depreciation and amortization: $30,000
• Interest expense: $10,000

SDE adds all four together: $150,000 + $120,000 + $30,000 + $10,000 = $310,000.

EBITDA adds back interest, depreciation, and amortization, but keeps a market-rate salary for the owner's role as an expense. If $120,000 is a fair market salary for that role, EBITDA is $150,000 + $30,000 + $10,000 = $190,000.

For the same business, the $120,000 difference is entirely owner compensation. If the owner paid themselves less than market, EBITDA would be adjusted downward to reflect what it would cost to hire a manager.

Why the difference matters to your price

Multiples are tied to the earnings measure they were built on. A multiple quoted for EBITDA applied to SDE will overstate value. A multiple quoted for SDE applied to EBITDA will understate it.

The buyer pools also differ. Owner-operators and individual buyers typically evaluate smaller businesses on SDE. Private equity groups and strategic acquirers typically evaluate larger businesses on EBITDA, and those businesses generally command higher multiples because they carry less owner-dependence risk. A business near the boundary can sometimes be positioned either way, and that positioning affects both the buyer pool and the outcome.

The add-backs have to hold up

Both measures depend on adjustments. Every add-back should be documented and defensible. Buyers and lenders will test them, and add-backs that cannot be supported are usually reduced or removed. See What Buyers Actually Look At in Your Financials.

Before you anchor on a number

When you hear a multiple from a colleague, an article, or an industry report, confirm which earnings figure it applies to and whether the businesses behind it are comparable to yours. For other common errors, see Common Mistakes in Business Valuation.

BusinessQuest Brokers provides confidential valuations for Southern California business owners, including a normalized earnings analysis. Request a valuation.

Frequently asked questions

What is the difference between SDE and EBITDA?

SDE includes one owner's full compensation as part of earnings. EBITDA treats a market-rate salary for the owner's role as an expense. SDE is therefore higher for the same business.

Which is used to value a small business?

Smaller, owner-operated businesses are usually valued on SDE. Larger businesses with management in place are usually valued on EBITDA.

Can I apply an EBITDA multiple to my SDE?

No. Multiples are specific to the earnings measure they were built on. Mixing them will misstate value.