What Is Seller's Discretionary Earnings (SDE)? A Simple Guide

If you're thinking about selling your business, you'll hear the term "SDE" constantly. Seller's Discretionary Earnings is the foundation of how most small businesses are valued.

Here's what you need to know.

What Is SDE?

Seller's Discretionary Earnings represents the total financial benefit a single owner-operator receives from the business. It's the "true" cash flow available to an owner.

The simple formula:

Net Income + Owner's Salary + Owner Benefits + Interest + Depreciation + One-Time Expenses = SDE

Why add these back? Because a new owner will have their own salary, their own benefits, their own debt structure. SDE normalizes the business to show what's actually available.

Calculating SDE: Step by Step

Start with your net income from your tax return or P&L. Then add back:

Owner's compensation:

• Salary and wages paid to you
• Payroll taxes on your salary
• Health insurance (if paid by the business)
• Retirement contributions
• Any other owner benefits

Interest and depreciation:

• Interest expense (the buyer will have their own financing)
• Depreciation and amortization (non-cash expenses)

One-time and non-recurring expenses:

• Legal fees for a one-time lawsuit
• Moving or relocation costs
• Major repairs that won't recur
• Consulting fees for specific projects

Personal expenses run through the business:

• Personal vehicle expenses beyond business use
• Travel that wasn't business-related
• Meals and entertainment beyond normal business
• Family cell phones or other personal items

Expenses that won't continue:

• Salary for a family member who doesn't really work there
• Above-market rent if you own the building
• Donations or sponsorships at your discretion

Example Calculation

Let's say your P&L shows:

• Net Income: $80,000
• Owner's Salary: $120,000
• Owner's Health Insurance: $15,000
• Interest Expense: $5,000
• Depreciation: $20,000
• One-time legal fees: $10,000
• Personal car expenses: $8,000
• Wife on payroll (doesn't work): $30,000

SDE = $80K + $120K + $15K + $5K + $20K + $10K + $8K + $30K = $288,000

This business produces $288,000 in SDE, even though the tax return shows only $80,000 in net income.

SDE vs. EBITDA

You'll also hear about EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). What's the difference?

SDE includes the owner's salary and benefits. It assumes one owner-operator will run the business.

EBITDA does not include owner's salary. It assumes the business will pay a market-rate manager.

For small businesses under $1M in earnings, SDE is standard. For larger businesses, EBITDA becomes more common because they typically have management in place.

Rough rule of thumb: EBITDA = SDE - Market Manager Salary

If your SDE is $300K and a manager would cost $80K, your EBITDA is approximately $220K.

Why SDE Matters for Valuation

Small businesses are typically valued as a multiple of SDE:

Business Value = SDE × Multiple

The multiple depends on industry, size, risk factors, and growth potential. Common ranges:

• Restaurants: 1.5-2.5x SDE
• Service businesses: 2-3x SDE
• Home services (HVAC, plumbing): 2.5-3.5x SDE
• Medical practices: 2.5-3.5x SDE
• Professional services: 2-3x SDE

So if your business has $288,000 SDE and your industry typically sells at 2.5x:

$288,000 × 2.5 = $720,000 estimated value

Common Mistakes

Overstating add-backs. Buyers will scrutinize every adjustment. If you claim $50K in personal expenses but can't document them, you lose credibility.

Forgetting the flip side. Some "add-backs" come with catches. If you add back your wife's salary, the buyer might need to hire someone for that work.

Not having documentation. Every add-back should be supportable. "Trust me, that was personal" doesn't work in due diligence.

Confusing SDE with cash. SDE isn't what you take home — it's what's available before you decide how to use it (salary, reinvestment, distributions).

How Buyers Use SDE

When a buyer looks at your SDE, they're asking:

"If I buy this business and pay myself a reasonable salary, what's left over?"

Let's say SDE is $300K and the buyer plans to take a $100K salary. That leaves $200K for debt service, profit, and reinvestment.

If the buyer finances $750K at 8% over 10 years, annual debt service is about $108K. That leaves roughly $90K in free cash flow.

This math is how buyers decide what they can afford to pay.

Improving Your SDE

You can increase SDE (and therefore your valuation) by:

Increasing revenue. More sales with the same cost structure means higher SDE.

Reducing unnecessary expenses. Cut costs that don't drive revenue.

Cleaning up personal expenses. Stop running personal stuff through the business.

Optimizing owner compensation. Pay yourself a reasonable salary — not too high, not too low.

Improving margins. Better pricing, lower COGS, more efficient operations.

Getting Your SDE Right

Before selling, work with your broker and accountant to calculate SDE properly. This means:

• Reviewing 3 years of financials
• Documenting every add-back
• Being conservative and defensible
• Having support for any unusual adjustments

A well-documented SDE calculation makes buyers confident. Sketchy add-backs make them walk away.

---

Want to understand what your business might be worth? Check valuation multiples by industry or schedule a conversation to discuss your specific situation.