Plain-English explainer

What is SDE? The number that prices a business.

SDE is the number that turns a business's raw profit into what you are actually buying: the earnings one working owner takes home in a year. Here is the formula in plain words, one worked example, the honest test for every addback, and how that number turns into a price and a loan.

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What SDE actually is

The profit that follows the owner home

Seller's discretionary earnings, SDE, is the profit a business truly puts in one working owner's pocket in a year. Start with pre-tax profit. Add back the owner's salary and payroll taxes, because a new owner replaces that pay with their own labor. Add back perks the business paid for that a new owner would not have to keep paying: a personal vehicle, a family member on payroll who will not stay, memberships that served the owner rather than the business. Add back genuine one-time costs too, a roof replacement, a lawsuit settlement, anything that will not repeat. What is left is SDE, the real number a buyer steps into.

Here is that math on a clean, plausible example: $180,000 pre-tax profit + $110,000 in owner salary and payroll taxes + $25,000 in perks and one-time items = $315,000 in SDE. That $315,000 is the number a buyer, a lender, and a broker will all end up discussing, and the number the rest of this page is really about.

Why not net income

Net income hides the owner's real paycheck

Owner-operated businesses do not keep their books for a buyer's benefit. They keep them to minimize tax, and the owner's own pay and personal spending often sit buried inside ordinary expense lines: officer compensation set for tax reasons rather than market rate, a vehicle, a phone plan, a relative drawing a paycheck for light duties. Net income, the bottom line on a tax return or a profit and loss statement, reflects all of that. It answers a different question than the one a buyer is actually asking.

The question a buyer needs answered is simple. If you step into this owner's chair, what does the business really produce for you in a year? Net income understates that number, sometimes badly, because it was never built to answer this question. SDE rebuilds the figure from the ground up, addback by addback, until it reflects what a new working owner actually takes home.

The addback test

Would the next owner really not pay this?

Every addback deserves the same honest question. Would the next owner really not pay this? A personal vehicle the business currently covers usually passes that test. So does a one-time legal bill, or a roof that will not need replacing again for twenty years. A repair that quietly shows up every single year, dressed up as one-time, does not pass, no matter what the spreadsheet calls it. Neither does a below-market rent from a landlord who happens to be related to the seller and is about to reset to market rate the day the deal closes.

Inflated addbacks are the single most common way a listing overstates SDE, and they rarely arrive as one dramatic lie. They arrive as a dozen small, generous judgment calls, stacked on top of each other, until the number looks better than the business actually performs. This same test, and the same discipline, matters again when you sit down to read a CIM: the addback schedule buried inside that packet deserves exactly this level of scrutiny, line by line, before you let it move your price.

From earnings to price

A multiple prices it. Coverage decides the loan.

Once you trust the SDE number, a buyer applies a multiple to it to arrive at an asking price or an offer. That multiple is not fixed, and this page will not hand you one. Multiples move with the size of the business, the industry it competes in, and how transferable its earnings really are once the current owner walks away. The same $315,000 SDE can price very differently on a business that runs itself versus one where every customer relationship lives in the owner's head.

A lender cares about something stricter than any multiple. They want to know whether SDE covers the loan payments the deal creates, with room to spare. That test has a name, DSCR, debt service coverage ratio, and it is a separate question from what a buyer or seller thinks the business is worth. See what DSCR is and what lenders actually require before you anchor to a price built on SDE alone.

Is SDE the same as EBITDA?

They sit in the same family but treat owner pay differently. SDE adds back one full owner's compensation and payroll taxes, because a working owner replaces that pay with their own labor. EBITDA assumes hired management runs the business and leaves a manager's salary sitting in the costs. On an owner-operated business, that single difference can move the number substantially, so always ask which one a listing is actually quoting.

What counts as a legitimate addback?

Run every addback through one question: would the next owner really not pay this? A personal vehicle, a family member on payroll who will not stay, or a true one-time cost like a roof replacement usually pass. A repair that quietly repeats every year, a rent about to reset to market rate, or a discount the seller extended personally do not, regardless of what the listing calls them. The safest addbacks are the ones with paperwork behind them, not just a line in a spreadsheet.

Who calculates SDE, and can I trust the listing's number?

The seller or their broker calculates it first and puts it in the listing or the CIM. Treat that figure as a starting claim, not a verdict. Rebuild it yourself from the tax returns and the profit and loss statement, addback by addback, before you let it anchor your price. A number nobody has independently rebuilt is a pitch, not a fact.

Does the bank lend on SDE?

The bank lends on debt service coverage, not on SDE by itself. SDE is the input, and DSCR is the test that compares that earnings figure to the loan payments the deal creates. An addback-heavy SDE that underwriting cannot verify, or one that does not survive their own recalculation, will not carry a loan on its own. What a lender wants is SDE landing comfortably above what the debt service requires, which is exactly what DSCR measures.

Your real SDE, before you offer

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