SDE vs EBITDA: Which Metric Should You Use?

Defining the Terms

Seller's Discretionary Earnings (SDE) represents the total financial benefit available to a single owner-operator. It starts with net income and adds back owner's salary, owner's perks, interest, taxes, depreciation, amortization, and one-time or non-recurring expenses. SDE answers the question: how much does this business generate for the owner?

EBITDA starts with net income and adds back interest, taxes, depreciation, and amortization. But it does not add back a market-rate owner's salary. EBITDA represents the operating earnings available to pay debt service, taxes, and provide a return to equity holders after accounting for management compensation.

When to Use SDE

SDE is the standard metric for valuing small businesses (generally under $1-2M in revenue) where the owner is actively involved in daily operations. In these businesses, the owner's compensation is the largest single expense, and it varies dramatically based on how much the owner pays themselves. By adding back the owner's total compensation, SDE normalizes for this variation and enables comparison across businesses.

Typical SDE multiples range from 1.5-4.0x depending on industry, size, growth, and risk factors. When you see a business listed for "3x SDE," the buyer is expected to derive their compensation from the SDE amount.

When to Use EBITDA

EBITDA becomes the appropriate metric when the business is large enough to require a paid management team regardless of ownership. This transition typically happens around $1-3M in revenue, depending on the business complexity. At this level, the business can and does pay a market-rate manager or CEO, and that cost is a real, ongoing operating expense.

EBITDA multiples for private companies typically range from 3-8x and can go higher for larger, high-growth, or strategically valuable businesses.

Common Mistakes

The most common valuation error is applying EBITDA multiples to SDE calculations (or vice versa). Because SDE includes the owner's compensation and EBITDA does not, SDE is always higher than EBITDA for the same business. Using an EBITDA multiple on an SDE figure dramatically overstates value.

Another frequent mistake is inconsistent add-back treatment. Every add-back should be documented, justified, and defensible. Aggressive add-backs inflate SDE or EBITDA and lead to unrealistic valuations that fall apart during due diligence.

Practical Example

Consider a business with $500,000 in net income. The owner pays themselves $200,000, has $50,000 in perks (car, phone, travel), and the business has $30,000 in depreciation and $20,000 in interest expense.

• SDE = $500,000 + $200,000 + $50,000 + $30,000 + $20,000 = $800,000
• EBITDA = $500,000 + $30,000 + $20,000 = $550,000 (assuming the $200,000 salary is market rate)

At a 3x multiple, the SDE valuation is $2.4M while the EBITDA valuation is $1.65M. The right answer depends on whether the buyer plans to operate the business (SDE-based) or install management (EBITDA-based).