Seller’s discretionary earnings (SDE) is a calculation of the net monetary benefits that come out of a business. It’s calculated by taking the net income of the business and adding back the owner’s salary as well as all of the benefits that go to the owner (e.g. travel expenses, health insurance, tax payments, interest, and amortization). Other expenses may be added provided that they are not necessary to the operation of business.
SDE is one metric used by brokers, business owners, and business buyers to determine the value of businesses. In combination with a value multiplier, the SDE helps arrive at a reasonable value estimate for a business. The view is that all of the benefits of the business are available to pay for the business itself, less, of course, a reasonable salary for the owner for working in the business.
Traditionally, SDE is used for businesses that have $1 million or less in gross revenue, and EBITDA (earnings before interest, taxes, depreciation, and amortization) is used for businesses that are in excess of $2 million in gross revenue. The area in between $1 million and $2 million is a little bit gray, and you can use either metric to determine cash flow. This area is also precisely where it’s important to have an experienced and qualified team on your side to assess the valuation methods of the seller or buyer.
Learn more about business valuation methods!