The Difference Between EBITDA And SDE For Business Valuation
What Does EBITDA Mean?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization.
It shows how much cash a company produces from its core operations. It ignores financing decisions and tax settings.
Many analysts like EBITDA because it gives a cleaner view of operating performance.
Public companies often use EBITDA. Large private firms use it too.
EBITDA assumes that the company runs without a single owner who draws a personal salary.
It assumes a management team is in place. It also assumes that the firm can replace any leader at a market rate.
This point matters;
If a firm depends on one owner who works full-time in the business, EBITDA will not capture the economic value of that work.
Related: How To Value A Company With Negative EBITDA
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What Does SDE Mean?
SDE stands for seller's discretionary earnings. It shows how much cash the owner takes out of the business.
It adds back the owner's salary and personal perks that run through the business. It also adds back interest, taxes, depreciation, and amortization.
SDE helps buyers understand how much cash flow they can expect if they step in as the new owner.
The Small Business Administration (SBA) defines SDE in its loan guidance for small deals. Many brokers use it for firms with less than 5 million dollars in revenue.
SDE works well for owner-operated firms.
These firms depend on one person who plays many roles. That person may draw a salary. They may also run some personal items through the business.
The SDE metric adds these back so that the cash flow reflects the value to a new owner who will step into that role.
SDE Vs EBITDA: Key Structural Difference
This is the KEY difference between EBITDA and SDE: EBITDA removes the owner, while SDE includes the owner.
This results in completely different numbers…
A small firm may show 300,000 dollars of SDE.
That same firm may show only 150,000 dollars of EBITDA once you include a market-rate salary for the owner.
Buyers need to understand this gap. It can change the valuation by a wide margin.
When Should You Use EBITDA?
You should use EBITDA when the company you’re valuing has a full management team.
Use this metric when no single person controls daily operations.
You can also use the metric when the firm has revenue big enough to sustain professional managers.
Most firms above 5 million dollars in revenue fall in this group.
Lenders also prefer EBITDA in mid-market deals.
Reports show that lenders tend to rely on EBITDA for debt coverage ratios in deals above 5 million dollars. This helps them judge repayment ability.
EBITDA also supports higher valuation multiples in mid-sized deals. Buyers pay more because they expect lower risk.
A 2023 IBBA Market Pulse report shows that firms with EBITDA above 1 million dollars often sell at 5 to 6 times EBITDA.
These firms have better systems and less owner dependence.
When Should You Use SDE?
You should use SDE when you want to value a small owner-operated firm. These firms may earn between 500 thousand and 5 million dollars in revenue.
The owner often handles sales, operations, and finance.
A perfect example is when you’re buying an established e-commerce business.
Lenders understand this structure. The SBA uses SDE for many loans below 5 million dollars. It helps them see the cash flow available to a new owner who will replace the seller.
Buyers also use SDE to judge how much they can pay themselves.
In a recent Insight Report, BizBuySell notes that over 80% of small business listings use SDE as the main cash flow metric.
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EBITDA vs SDE Impact On Valuation Multiples
Valuation multiples differ based on the metric. SDE multiples are lower than EBITDA multiples. This is normal because small firms carry more risk.
A typical SDE multiple for small firms ranges from 2 to 3.5 times SDE. For example, a firm with 300,000 dollars of SDE may sell for 600,000 to 1,050,000 dollars.
Mid-sized firms use EBITDA multiples. These range from 4 to 7 times EBITDA based on industry, growth rate, and customer spread.
A firm with 1 million dollars of EBITDA may sell for 4 to 7 million dollars.
This distinction matters;
If a seller applies a mid-market EBITDA multiple to an owner-operated SDE firm, the price will be unrealistic. Buyers will walk away fast.
Adjustments and Add Backs To Keep In Mind
Both EBITDA and SDE use adjustments. The goal is to present a fair picture of ongoing cash flow.
SDE adds back the owner's salary and personal perks. It may add back one-time costs like legal fees for a lawsuit or costs from a short-term project.
EBITDA uses fewer adjustments. It adds back non-cash items like depreciation. It does not add back owner perks because a large firm should not have them in the first place.
Sellers often misuse add-backs. Buyers need to test every adjustment.
A 2023 survey by the International Business Brokers Association showed that buyers reject over 30% of proposed add-backs in small deals.
This shows why careful review matters.
Industry Use of The Two Metrics:
Some industries lean toward one metric. Professional services and small retail use SDE often. Manufacturing and tech use EBITDA more.
Franchise resales use SDE because the owner often works inside the business. Healthcare practices are split between the two based on size and staffing.
Industry reports confirm this pattern. For example, BizBuySell data shows that over 75% of restaurant and retail deals use SDE.
How To Decide The Right Metric To Use
As a buyer, you should ask yourself this one question first to help you decide which metric to use:
Will I replace the owner, or will I hire managers to replace them?
If the buyer plans to replace the owner, then going with SDE is a safer bet. It shows how much cash the buyer can pull after the purchase.
If the buyer plans to hire managers and run the firm as an investor, EBITDA matters.
It shows how much cash the firm will produce after paying a market-rate management team.
This choice shapes the entire deal structure. It also shapes how much debt the buyer can take on. Lenders will ask for the right metric for the deal size.
Check out this video where our expert shares a proven 3-step formula for evaluating any business opportunity before you invest in it:
Conclusion
EBITDA and SDE are common valuation multiples for businesses on sale, but they serve different roles.
EBITDA is ideal for valuing mid-sized firms with stable teams. SDE fits small owner-operated firms where one person drives daily activity.
Choosing the wrong metric can lead to poor expectations and make poor offers. The best move here is to match the metric to the structure of the business.
When you do this right, you get a cleaner view of cash flow and a fairer valuation.
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