SDE: The Valuation Metric That Drives Small Business Prices
Seller's Discretionary Earnings (SDE) is the total economic benefit an owner-operator receives from a business in a given year. It's the primary valuation metric for small business acquisitions — the number that gets multiplied by an industry multiple to produce the asking price.
If a business sells for "3× SDE" and SDE is $200,000, the purchase price is $600,000. Understanding SDE — and verifying it — is the most important financial skill in small business acquisitions.
The SDE Formula
SDE = Net Income + Owner Salary & Benefits + Depreciation & Amortization + Non-Recurring Expenses + Personal Expenses Run Through the Business
This is the output of the financial recasting process. Each line represents a category of add-back.
SDE vs. EBITDA
The critical difference: SDE adds back the owner's entire compensation (salary + benefits + any other personal economic benefit), treating the business as if one person captures all the economic value. EBITDA, by contrast, subtracts a market-rate management salary — it assumes a hired professional runs the business.
This matters because SDE is the right metric when the buyer plans to work in the business as an owner-operator (capturing all earnings). EBITDA is right when the buyer plans to hire a manager (one layer of earnings goes to that manager's salary before the buyer sees returns).
| Metric | Who it's for | Typical multiple |
|---|---|---|
| SDE | Owner-operators; businesses under ~$2M earnings | 2× – 4.5× |
| EBITDA | Platform acquisitions; PE; management-run businesses | 4× – 10×+ |
What a Good SDE Number Looks Like
SDE multiples are driven by business quality, not just industry. Within any sector, businesses at the high end of the multiple range typically have:
- Multiple years of stable or growing SDE (not a single good year)
- Diversified customer base (no customer concentration)
- Documented processes and a team that runs without the owner daily
- Transferable contracts and relationships (low key man risk)
- Clean, auditable financials that reconcile to tax returns
Trailing 12 Months vs. Average
SDE is usually calculated based on the trailing 12 months (TTM) — the most recent year of operation. For businesses with recent growth, sellers prefer TTM (higher). For businesses with a recent dip, sellers may push for a 3-year average (smoother). Buyers should understand which basis is being used and model both. For cyclical businesses, a 3-year average is more reliable; for businesses with clear and sustainable revenue growth, TTM may be appropriate.
Common SDE Mistakes
- Adding back recurring expenses as "one-time" — marketing spend, equipment maintenance, and professional fees that recur annually aren't add-backs
- Adding back a replacement role — if the owner does sales and a new owner would need to hire a salesperson, that salary can't be fully added back
- Not verifying against bank statements — SDE built from P&L alone can be inflated; deposits don't lie
Related Terms
- Add-backs — the individual adjustments that build up SDE
- Recasting financial statements — the process that produces SDE
- Enterprise value — how SDE multiples relate to total deal value
Sources & Further Reading
- IBBA Market Pulse — quarterly data on SDE multiples by industry and deal size
- BizBuySell Insight Report — transaction data on how SDE translates to purchase price in real deals