What Is SDE? Seller's Discretionary Earnings Explained
By Ian Folau and Byron Folau · Business Broker Brothers
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SDE (Seller's Discretionary Earnings) is the total financial benefit the owner of a business receives in a year — net profit plus the owner's salary and any personal or one-time expenses the business carried. It is the number most small businesses are valued on, and it is usually the first figure a buyer asks for.
How is SDE calculated?
SDE starts with the profit the business reports, then adds back everything that flows to the owner or won't continue under a new owner. The formula:
SDE = Net profit + owner's salary + interest + depreciation & amortization + one-time expenses + personal (discretionary) expenses
The logic behind each add-back: a new owner won't pay the current owner's salary (they'll pay their own, or a manager's — that's already counted on the EBITDA side), lenders replace interest costs, and one-time or personal costs — a family vacation booked as travel, the owner's car payment, a lawsuit settled last year — aren't part of ongoing operations.
Here's a simple worked example with clearly illustrative numbers. Say a landscaping business shows this on its books:
| Line item | Amount (illustrative) |
|---|---|
| Net profit | $120,000 |
| Owner's salary + payroll taxes | + $80,000 |
| Interest on the truck loan | + $6,000 |
| Depreciation | + $9,000 |
| One-time legal settlement | + $15,000 |
| Owner's vehicle and phone (personal) | + $10,000 |
| SDE | $240,000 |
On paper the business "made" $120,000. But the owner actually received $240,000 of benefit once their salary and the add-backs are counted. That $240,000 is what a buyer is really purchasing — so that's the number the business gets priced on. Every add-back has to be documented and defensible; a buyer's accountant will check each one during due diligence.
SDE vs. EBITDA
Both are "normalized" earnings — they strip out items that distort the headline profit. The difference is the owner's paycheck:
| Item | EBITDA | SDE |
|---|---|---|
| Interest, taxes, depreciation, amortization | Excluded | Excluded |
| One-time / non-recurring expenses | Usually excluded | Excluded |
| Personal expenses run through the business | Usually excluded | Excluded |
| Owner's salary | Charged — a replacement manager's pay is deducted | Added back — full owner benefit included |
In practice: SDE is always equal to or higher than EBITDA, because it adds the owner's compensation back on top. Buyers of small, owner-operated businesses think in SDE — the owner is the one drawing the income. Buyers of larger companies with managers in place think in EBITDA, because they have to budget a market salary for whoever runs it day to day.
Which businesses are valued on SDE?
SDE is the standard for owner-operated small businesses — typically main-street and lower-middle-market companies where the owner works in the business and takes home most of its earnings. Think restaurants, landscaping companies, HVAC contractors, e-commerce brands, dental practices, and small manufacturing shops.
As businesses get larger and add professional management, the market shifts to EBITDA. A rough dividing line many brokers use: below roughly $1M in earnings, SDE dominates; once a company is big enough that a buyer isn't buying a job — they're buying a managed operation — EBITDA takes over. The financials a broker assembles will often show both, so the same business can be discussed with any buyer.
How brokers use SDE to price a business
The core valuation method for a small business is a multiple of SDE. The broker builds the normalized SDE from the last few years of financials, then applies a multiple that reflects the industry, the size of the business, customer concentration, how dependent the business is on the owner, and overall risk. Supported by comparable sales, that produces the price range the owner sees at listing.
Two things matter most here. First, the add-backs have to be real — inflating SDE with questionable add-backs is the fastest way to lose a deal in due diligence. Second, the multiple has to be defensible, not guessed. That combination — a clean SDE and a supported multiple — is what lets a broker stand behind the asking price when a buyer's accountant picks the numbers apart.
If you're learning to broker deals, SDE is a number you'll work with constantly — in valuations, in the CIM you prepare for buyers, and in every offer negotiation. Our valuation tool walks through building an SDE step by step.
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