SDE vs EBITDA: Key Difference
When selling your business, deciding between SDE and EBITDA can significantly impact your valuation. While Main Street deals love Seller’s Discretionary Earnings for its raw, owner-centric truth, Wall Street speaks fluent EBITDA for its clean, scalable story.
Choose wrong, and you’ll either confuse sophisticated buyers or undersell to local competitors. Choose right, and you’ll position your business exactly where it belongs in the market food chain.
The difference isn’t just accounting—it’s strategy.
In this article, we will review these widely used metrics and help you understand when and how to apply them in valuations.
What is SDE?
Seller’s discretionary earnings (SDE) refers to the business income that can be distributed, reinvested, or allocated to different discretionary items at the owner’s discretion.
This metric is often used to determine the valuations of small businesses, especially in acquisitions. With small businesses, we track SDE instead of other earnings metrics since owners can often unilaterally decide how income should be allocated to various expenses and their own compensation.
Formula for seller’s discretionary earnings (SDE)
Seller’s discretionary earnings (SDE) = Pre-tax income (EBT) + Owner’s compensation + Interest expenses + Depreciation and amortization (D&A) + Discretionary expenses + Non-recurring items
SDE’s key characteristics are as follows:
- Prominently used for small businesses: SDE is most applicable to small businesses, where the owner’s influence on operations and financial results is more significant than in larger, professionally managed companies.
- Captures the true value of a business: SDE reflects the total financial benefit generated by a business for its owner in a given period.
- Assesses the debt-servicing capacity of acquisition targets: SDE reflects the cash flows available for servicing the acquisition-related debt, making it a key measure in evaluating potential targets.
SDE calculation example
Suppose a business’s cash flows and non-cash expenses are as described below:
- Pre-tax income = $4,000,000
- Owner’s compensation = $1,200,000
- Interest expenses = $250,000
- D&A = $600,000
- Health insurance premium = $3,000
- Charitable contributions = $20,000
- Legal and consulting fees = $15,000
With this information, we can calculate the SDE in the following manner:
| Particulars | Amount |
|---|---|
| Pre-tax income | $4,000,000 |
| Owner's compensation | $1,200,000 |
| Interest expenses | $250,000 |
| D&A | $600,000 |
| Discretionary items | |
| Health insurance premium | $3,000 |
| Charitable contributions | $20,000 |
| Total discretionary items | $23,000 |
| Non-recurring items | |
| Legal and consulting fees | $15,000 |
| Total non-recurring items | $15,000 |
| Seller's discretionary income (SDE) | $6,088,000 |
What is EBITDA?
Earnings before interest, taxes, depreciation, and amortization (EBITDA) reflect a company’s financial performance after removing the impact of non-cash items and the debt structure. It tells you the value generated by a business through its operations. This metric is often used for valuing large companies.
Formula for Earnings before interest, taxes, depreciation, and amortization (EBITDA)
EBITDA = Operating income + D&A
Since operating income is the sum of net income, taxes, and interest expenses, EBITDA can also be calculated as:
EBITDA = Net income + Taxes + Interest expense + D&A
EBITDA’s key characteristics are as follows:
- Use in valuation: EBITDA is employed to calculate valuation multiples such as the enterprise multiple (EV/EBITDA), making it a common tool in corporate finance and M&A.
- Operating Focus:Helps isolate the core operational results, showing business performance without the impact of capital structure, tax rates, or significant one-off accounting effects.
- Management Ready: Helps isolate the core operational results, showing business performance without the impact of capital structure, tax rates, or significant one-off accounting effects
- Standardized Metrics: Not a GAAP metric, so companies can calculate EBITDA differently, but it remains popular because it presents a standardized way to judge profitability across peers.
- Scalability Indicator: Often seen as an indicator of a business’s ability to scale and generate cash flow available for debt repayment and reinvestment
EBITDA calculation example
Suppose a company’s financial performance can be summarized as follows:
- Net income = $663,600,000
- Taxes = $176,400,000
- Interest expenses = $160,000,000
- D&A = $200,000,000
Then, we can calculate its EBITDA in the following manner:
| Particulars | Amount |
|---|---|
| Net income | $663,600,000 |
| (+) Taxes | $176,400,000 |
| (+) Interest expenses | $160,000,000 |
| (+) D&A | $200,000,000 |
| EBITDA | $1,200,000,000 |
This demonstrates the bottom-up method for EBITDA, which is useful for quickly assessing core operating profit before non-operating and non-cash expenses
Key Differences: SDE vs EBITDA
The following table summarizes the key differences between SDE and EBITDA:
| Aspect | SDE | EBITDA |
|---|---|---|
| Best suited for | Small businesses with annual revenue less than $5 million | Large businesses with annual revenue of more than $5 million |
| Management structure | Owner-operated | Professional management |
| Treatment of owner compensation | Added back | Treated as a business expense |
| Typical valuation multiple | 2-4x the SDE | 4-8x the EBITDA |
| What kind of acquirer should use this metric? | Individual buyers | Strategic or financial buyers |
Eqvista – Unlocking value hidden in finer details!
Since every business has unique features, valuations are often qualitative as they are quantitative. It takes more than just number crunching to accurately deduce a business’s value. The Eqvista team navigates these complexities to deliver reliable valuations for client assets worth about $3 billion each month. Let us put our expertise to work for you. Contact us here!
