SDE vs EBITDA: Which Earnings Measure Fits Your Business Sale

Both start with net income and add back interest, taxes, depreciation and amortization. SDE then adds the total pay and benefits of one working owner and any non-recurring or personal expenses run through the business. Adjusted EBITDA instead adds back one-time items and replaces the owner's pay with what it would cost to hire a manager.

Say net income is $250,000, taxes are $70,000, interest is $15,000 and depreciation and amortization total $25,000, which makes EBITDA $360,000. Suppose the owner takes $180,000 in salary and $20,000 in benefits, and $15,000 of personal expenses run through the company.

In that case, if you add the $200,000 of owner pay and benefits and the $15,000 to EBITDA, SDE is $575,000. For adjusted EBITDA, suppose a general manager would cost $140,000. The owner cost is replaced by that amount, so if you add back $15,000 and the $60,000 difference, adjusted EBITDA is $435,000.

Multiples are built for a specific earnings measure. Because SDE includes the owner's pay, it is a larger number than EBITDA for the same business, and the multiple applied to it is lower. Mixing them overstates or understates value.

Say a buyer uses a multiple of four for EBITDA: applying four to $435,000 of adjusted EBITDA gives $1,740,000, but applying four to $575,000 of SDE gives $2,300,000, which is $560,000 too high. Sellers who quote an EBITDA-style multiple against their SDE set expectations that buyers will not meet.

Ask any broker or buyer which measure and which multiple they are using, and confirm how each adjustment is treated. Also compare your adjusted margin with businesses in your own industry, because a buyer will, and be ready to explain any large gap.

Use this decision guide:

• Choose SDE when one owner works in the business full time, the buyer will likely be an individual who plans to replace that owner, and the company has few or no managers.
• Choose adjusted EBITDA when the business has a management team that would remain, the owner's role can be filled by a hire, and buyers are investors, private equity or strategic acquirers.
• Show both when you are between the two, so each type of buyer can see the number they use.

There is no exact line where one measure gives way to the other. The question is whether a buyer must work in the business or can hire someone to run it, and what the business would earn after paying that person. As companies get larger and buyers become institutional, EBITDA becomes the norm and quality of earnings reviews become common, as described in the quality of earnings guide.

Every adjustment needs evidence, or a buyer will discard it. Build a schedule with these columns: the item, the amount for each year, the reason it is not part of normal operations and the document that proves it. Typical supported items include owner pay and benefits, personal vehicles and travel, one-time legal or moving costs and non-cash expenses.

Be careful with items that recur every year. A cost that appears annually is hard to call one-time, and buyers will treat it as normal. Also be careful with owner pay: an SDE calculation adds back one owner, and if a second family member draws pay for real work, that pay is generally a real cost.

Detailed lists of common items appear in the SDE add-backs list. To understand the multiple, see the small business revenue multiple guide.

Treat it as a starting point for a conversation, not a price. Buyers will test your earnings, and financing terms, growth and risk all affect the multiple. Compare your figure with recent sales of similar businesses, and use a range instead of a single number.

Keep tracking the measure through the year so you can spot trends before a buyer does,. If you want to model conversions and valuation scenarios, see the planning software comparison.

Finally, decide whether selling is the goal. Some owners find that a change in structure, such as hiring a general manager, raises both the value and the freedom to leave later, because it moves the business from an SDE valuation toward an EBITDA one.