SDE vs EBITDA Acquisition Valuation: Which One Should I Use?

Multiples are all over the place for SMB acquisitions.

Sellers want to use SDE "Seller Discretionary Earnings". Earnings without a manager.

Buyers want to use EBITDA.  Earnings with a manager.

What is EBITDA?

EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization.

It’s a common measure of financial performance used to value medium to large businesses.

The formula to calculate EBITDA is:

Net Income + Interest Expense + Depreciation Expense + Amortization Expense + Taxes

But, this is regular EBITDA and your business will be valued on a multiple of adjusted EBITDA.

You’ll want to adjust your EBITDA to remove any one-time expenses or revenue streams and normalize your salary.

For example, remove excess salaries beyond what a manager would need or personal expenses.

What is SDE?

SDE, or seller’s discretionary earnings, is the most common metric used to value small businesses.

It represents the entire financial benefit your business would provide to one full-time owner-operator.

SDE is calculated by taking your business’s net profit and adding back certain discretionary expenses.

An "add back" is an expense that is added back to find your SDE. Typical add backs include your owner's salary, your payroll taxes on your salary, interest, depreciation, and any personal expenses paid through the business.

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Let's go through an example:

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A $300k SDE business for 3x ($900k) may look cheap.

But with a $130k manager in place. Earnings are more like $170k.

And then the EBITDA multiple is 5.3x.

Things even out as you go bigger.

SDE and EBITDA converge as the manager's salary makes up a smaller % of the earnings.

EBTIDA is the norm for bigger deals.

The manager's salary often understates the talent of the owner.

They work more than they say and have years of experience in the business.

A husband and wife could be more like a GM and an office manager.

You may need to hire 2 people to cover their "part-time manager" work.