Valuation

SDE vs. EBITDA: Which One Prices Your Business?

Most small businesses are priced on SDE. Larger companies with a manager in place are priced on EBITDA. Which one applies to yours depends on who runs the business day to day.

The short version

SDE and EBITDA are two ways to state what a business earns. Neither one is simply the profit on a tax return. Each one adjusts that profit for a different kind of buyer.

SDE fits a business the owner runs in person. EBITDA fits a business a hired manager runs. The measure follows the way the business operates today.

Owners get tripped up when the two get mixed. A price quoted on one basis means nothing until you know which basis it is.

SDE in plain words

SDE stands for seller's discretionary earnings. It starts with the profit on the tax return. It then adds back the pay and perks the business gives its owner.

The usual add-backs are:

• The owner's salary
• Personal costs the company covers for the owner
• One-time costs that will not repeat

The logic is plain. A buyer who replaces the owner steps into that whole stream of cash. The salary the seller took becomes money the buyer can take or reinvest.

That is why SDE prices most small owner-run companies. Staffing firms of this size usually sell on SDE. So do service companies and consulting practices.

EBITDA in plain words

EBITDA is short for a longer phrase. It means earnings before these costs are taken out:

• Interest
• Taxes
• Depreciation
• Amortization

One more rule sets EBITDA apart. The business is charged for management before the number is stated. A paid manager's salary counts as a cost of running the company.

So the owner's pay does not get added back. The number shows what the business earns on its own. It stays the same no matter who owns the company.

That is why buyers use EBITDA on larger companies. It lets them compare two businesses without untangling each owner's pay choices.

The same business, both ways

Here is one set of books run through both measures. The company is an example built to show the math.

Nothing about the business changed between the two totals. Only the question changed. SDE asks what the working owner takes out of the business.

EBITDA asks a different question. It asks what is left after paying someone to run the business. Both answers are honest because they describe different things.

Why the multiple changes with the basis

A price is earnings times a multiple. The multiple only makes sense next to the basis it was built on.

SDE is the bigger number. Its multiple is therefore the smaller one. EBITDA is the smaller number, and its multiple is the bigger one.

As typical education, small companies often sell at roughly two to four times SDE. EBITDA multiples at this size often run higher because the base number is lower. These ranges are market education and not a quote on any business.

The costly mistake is crossing the two systems. An SDE figure priced at an EBITDA multiple overstates the value by a wide margin. Always ask which basis a quoted price uses.

Add-backs buyers accept and reject

Every add-back gets tested when a buyer reviews the books. Buyers accept add-backs they can document. They reject anything that is really a normal cost of staying in business.

Buyers usually accept

• Owner salary above what a manager would cost
• A personal vehicle the business pays for
• A one-time legal bill
• Personal insurance the company carries for the owner

Buyers usually reject

• Normal wages for the crew
• Rent on the space the business uses
• Ongoing marketing spend
• Any cost the buyer will still pay after closing

A rejected add-back does more than lower the number. It makes a buyer read the rest of the list with doubt. Keep the list short and keep the proof for every line.

FAQ