- SDE and EBITDA are key financial metrics that help assess business performance. SDE focuses on owner benefits and EBITDA focuses on operational profitability.
- SDE is typically most relevant for small businesses with a very involved owner, whereas larger companies almost always use EBITDA as it is more standardised.
- Correct calculation and clear adjustments of both SDE and EBITDA are critical for an accurate business valuation and to make an informed decision.
- Buyers should align their choice of metric with their profile, business size and industry norms to better evaluate opportunities.
- Metrics such as SDE and EBITDA multiples can strengthen the buy-side.
- Rigorous due diligence, which includes verifying financials and reviewing add-backs or capital requirements, prevents common buyer mistakes and enables good acquisition decisions.
What is SDE vs EBITDA? – Explained here for first time buyers. SDE stands for Seller’s Discretionary Earnings, which is the profit the business makes before removing the owner’s pay and some other costs. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation and provides a picture of income before these large expenses are deducted. Buyers typically use SDE for small businesses and EBITDA for bigger firms, as each highlights value differently. Understanding the basics of SDE and EBITDA helps buyers choose the right instrument for their requirements. Here’s the difference between them and when to use each one…
What Are SDE and EBITDA?
SDE, or Seller’s Discretionary Earnings, and EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, are both crucial financial metrics used to measure business performance. While SDE captures all financial benefits an owner receives, including salary and perks, EBITDA focuses on operating profit by stripping out costs unrelated to daily operations. Understanding these valuation multiples is essential for buyers to accurately assess what a business is worth and to compare different valuations. This knowledge is particularly beneficial for small business owners, helping them make informed decisions and avoid overpaying.
1. The Owner’s View
SDE is a clear indicator for owners as their overall take home value from the business. It tallies wages, dividends and private overhead such as a car or phone run through the company. That provides an accurate representation of what an owner truly gets each year.
Discretionary expenses make up a large part of SDE. They can be discretionary additions, for example, personal travel or family health cover, that may not remain with the business if it is sold. SDE helps owners and buyers see the true cash flow that would be left if they took over. SDE is often subject to owners manipulating certain costs included and excluded based on their own methodology.
2. The Investor’s View
Investors lean on EBITDA to gauge how the business performs with no owner influence. It strips out non-operational items such as interest and tax to demonstrate what the core business is making.
EBITDA is helpful for comparing different size or sector companies. It provides a consistent way to view cash flow and profitability. Investors work out value using EBITDA, which stands for “earnings before interest, taxes, depreciation and amortisation,” typically applying a multiple to arrive at a fair price. It is an important measure for private equity and buyers searching for consistent, recurring profits.
3. The Calculation
To calculate SDE, begin with net income. Then add back the owner’s pay, perks and discretionary costs. For EBITDA, take net income and add interest, tax, depreciation and amortisation back, stripping out the individual flair.
Typical SDE add-backs include private insurance or family wages. As for EBITDA, we are adjusting for such non-cash costs as depreciation. A straightforward table showing both calculations can reveal the gap, which can be well over £100,000, and illustrate how it impacts value.
4. The Adjustments
SDE consists of usual add-backs such as personal expenses, family salaries or one-off legal costs. These demonstrate the true owner-operator advantage.
EBITDA adjustments strip out things like depreciation to focus purely on core profit while leaving aside loan repayments or tax bills. This can affect how profitable a business appears.
Adjustments can move the figures a long way. If not obvious, they can confuse buyers. It’s important to keep all adjustments transparent and honest so buyers can trust the numbers and make fair offers.
The Fundamental Difference
SDE and EBITDA are two critical financial metrics often referenced during a small business valuation, yet they serve different purposes. SDE, or Seller’s Discretionary Earnings, illustrates the total cash flow available to a small business owner by adding back the owner’s salary, benefits, and personal expenses associated with running the business. In contrast, EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortisation, focuses on operational profit, making it a powerful valuation tool for larger businesses with established management teams. This distinction is crucial as it influences how different valuations are approached and what strategic buyers prioritize. Selecting the right valuation method based on the company’s size, ownership structure, and buyer profile ensures a strong valuation that accurately reflects the business’s economic value.
Owner’s Role
SDE is tailored by the owner’s day-to-day usage. If an owner is running the company, then their salary, personal benefits and sometimes a few personal costs to profit are added back. This can push SDE up, but makes it look skewed, particularly if personal expenses are rolled in with business ones.
Big corporate run by professional managers use EBITDA instead. For us, the owner’s salary isn’t front and centre, and the business doesn’t depend on one person being there. EBITDA ignores owner-specific benefits and facilitates comparison of companies.
Buyers need to consider how closely the business is tied to its owner. High SDE might indicate a business needing a hands-on owner-manager while EBITDA suggests greater independence from any individual.
Business Size
Small businesses, generally under $1M in annual revenue, rely on SDE. It helps demonstrate to a potential owner what they might get to take away for themselves. Bigger companies, generating more than $1M in revenue, are better matched to EBITDA, which is more industry-agnostic and removes owner impact.
The scale of the company alters what customers care about. Small businesses attract people who want to step in as owner-operators. Large companies attract investors or other firms seeking robust management and reliable cash streams.
Valuation methodologies need to suit the business. Employing SDE for a larger company may undervalue it. Using EBITDA for a small owner-run shop can miss important cash flows.
Buyer Profile
Individual purchasers will focus on SDE because it’s what they’ll take out of the business if they operate it. Institutional buyers, such as private equity or big firms, favour EBITDA because it provides a lucid, like-for-like account of profits before financing and tax decisions.
Strategic buyers, looking to merge or expand, might care more about EBITDA, particularly if they intend to recruit new managers. Financial buyers, thinking of personal returns, may narrow in on SDE. Aligning the metric with the buyer’s goals prevents confusion and discordant expectations.
Which Metric Should You Use?
SDE and EBITDA are both powerful valuation tools used to value businesses, particularly in small business valuation. Each metric suits different sized businesses, depending on ownership structure and how the business is run. First-time buyers often face the challenge of selecting the right valuation method, as this choice can significantly alter the true price.
Prioritise SDE
Why should you use it? For smaller businesses – particularly those with less than £5 million in annual earnings – SDE is usually more useful. Where the owner is heavily involved – managing staff, selling, even the accounts – SDE demonstrates the actual cash flow more convincingly. This valuation method incorporates the owner’s salary, perks, and anything that’s discretionary spend that benefits the business owner. This makes it perfect for shops, small e-commerce stores below the £2 million turnover mark, or personal touch service providers where the owner’s style creates the day.
SDE gives buyers an appreciation for what their cash flow would be if they were in the owner’s shoes. It shows the combined financial benefit: salary and profits, which is crucial for small business valuation if the business can’t operate well without the owner’s involvement.
SDE can be a powerful negotiating tool for buyers. If a company is dependent on one individual, it may be worth less if that individual departs. For instance, a boutique consultancy with one big client, which accounts for more than 25% of revenue, should use SDE because EBITDA may exaggerate its value compared to other valuation multiples.
Even so, buyers should compare SDE with other figures, such as revenue trends or gross profits, to get the complete picture. There is no single valuation metric that tells the entire story.
Prioritise EBITDA
EBITDA suits bigger businesses, typically those generating more than $1.5 million annually, where the owner’s departure wouldn’t halt the business. If the company is running well with a management team intact, EBITDA indicates how much cash the business can produce from its core activities, before paying interest, taxes or non-cash expenses.
It aids buyers to compare companies in the same industry. For instance, larger online retailers or manufacturing companies tend to employ EBITDA, as it gives a more accurate perspective on operational performance. It has implications for buyers looking for growth or intending to tuck in outside investors.
Institutional investors and PE groups like EBITDA because it removes owner-specific costs. It makes benchmarking simpler and assists with decisions around whether to scale, consolidate or even resell down the line.
Comparing EBITDA between companies can showcase efficiency, cost control and earning power. It only works well when the business can operate independently, without the owner’s daily involvement.
SDE vs EBITDA: Key Considerations
| Factor | SDE | EBITDA |
|---|---|---|
| Owner Involvement | High | Low |
| Business Size | Under $5 million | Over $1.5 million |
In the realm of small business valuation, particularly for e-commerce and scalable sectors, understanding the right valuation method is crucial. Investors, including private equity firms and strategic buyers, often rely on cash flow-based metrics, such as the ebitda multiple, to gauge the economic value of a business, ensuring a strong valuation.
How Metrics Influence Price
Metrics such as SDE and EBITDA play a crucial role in how buy and sell side approaches determine what a company is worth. SDE multiples reflect the value of small, owner-operated businesses, while EBITDA multiples feature prominently in large and more complex deals. Both metrics serve as powerful valuation tools to define price expectations and negotiation tactics. Analyzing how these valuation multiples have evolved over time can assist prospective buyers in assessing whether the price is fair.
SDE Multiples
SDE multiples compare the seller’s discretionary earnings to the sale price, providing a ballpark figure for small businesses. If a bakery has a yearly SDE of €100,000 and sells for €300,000, the SDE multiple is three times.
Industry norms have a large bearing on SDE multiples. Service-based outfits might command higher multiples than retail for more consistent profits. Sellers must know the average swath for their industry before negotiations.
Understanding the correct SDE multiple can prevent buy-side parties from overpaying and inform strong bids. It helps in justifying or questioning a seller’s asking price when negotiating.
| Industry | SDE Multiple (Range) |
|---|---|
| Retail | 1.5× – |
| 2.5× |
| Hospitality | Two times minus three times | | Professional Services | Two point five times minus three point five times |
| Online Businesses| 2.5× – 4× |
EBITDA Multiples
EBITDA multiples are the standard for bigger companies and connect performance to price. A business with €1 million EBITDA and a six times multiple might be worth €6 million.
Multiples differ by sector. Tech and SaaS companies can score between 8 times and 20 times, while retail or hospitality usually attain between 2 times and 4 times. Market trends, growth outlook and risk can swing these figures either way. For example, dependence on one big customer or high capital requirements can impact multiples significantly.
EBITDA multiples show buyers hot deals. Two companies with identical EBITDA analogs can be valued quite differently if one has a superior customer mix, cash cycle or capital requirements.
Adjusted EBITDA, stripping out one-off expenses, provides a more vivid picture of “running” profit. Checking historical multiples assists buyers in identifying outliers and establishing just prices.
Negotiation Levers
Having SDE and EBITDA knowledge gives buyers leverage. A business with healthy, consistent EBITDA or SDE can command a premium, particularly with evidence of growth or minimal debts.
Transparent, itemised finances foster trust and reinforce a buyer’s position. It’s wise to examine both metrics, identify perils such as a sluggish cash cycle or significant capital expenditure, and revise proposals accordingly.
Examining both figures and industry averages allows buyers to enter negotiations well armed and prepared to defend their offer or dispute the seller’s assertions.
Reading Between the Lines
The figures do speak for themselves, especially when considering SDE business and EBITDA multiples. First-time buyers should pay attention to what these valuation metrics reveal about how a business operates, the owner’s decisions, and the greater market. Each measure prefigures its limits, and going deeper uncovers risks and genuine value.
The Story Behind SDE
SDE reflects not just revenue and expenses but the owner’s habits, perks, and personal costs. For small business valuation, these often blend with daily operations, such as a car lease, family phone plans, or travel counted as business costs. One-off events or discretionary spending can make SDE look better than it is and can mask real problems. If an owner takes a large salary or runs personal bills through the business, the SDE business valuation may seem higher, but it needs adjustment. Buyers must ask for proof, check receipts, and get clear on what is personal versus core business. Missing these details can mean overpaying or missing red flags. A good SDE analysis looks at all factors, including industry, customer mix, cash flow, and how often owners dip into the business for non-essential expenses. This broader view helps buyers judge if earnings are sustainable or propped up by short-term tricks.
The Reality Behind EBITDA
EBITDA is a well-liked tool for comparing companies, but it omits critical costs such as loan payments, capital expenditure, and variations in working capital. This can present a rosier picture than reality, particularly if a firm has just had a large, one-off sale or made unsustainable cuts. Adjusted EBITDA, a powerful valuation tool, can assist by stripping out one-off revenue or individual expenses, but this is still only one side of the story. Buyers should examine alternative metrics, including cash flow, customer spread, and industry standards, to get a complete picture of small business valuation. Not every high-EBITDA business is low-risk, as a company with one key customer may be more dangerous than its figures imply.
Verifying the Figures
Diligence is essential in small business valuation. Buyers need books, matching receipts, and tax returns to verify that the SDE business and EBITDA figures are correct. Seeking out external audits or third-party reviews can provide more reassurance. Gaps or anomalies in accounts should be scrutinized, as trustworthy numbers emerge from transparent, truthful documentation, ensuring a strong valuation.
Common Buyer Pitfalls
Buyers comparing SDE business and EBITDA often overlook pitfalls that can distort their perception of a company’s intrinsic worth. These common valuation multiples can lead to poor buying decisions, increased risks, or overpaying for a commercial asset. Understanding the top pitfalls in these valuation methods helps prevent costly mistakes and provides a clearer picture of what a business is truly valued at.
Overlooking Add-Backs
Overlooking important add-backs in SDE calculations is a common problem. SDE frequently factors in the current owner’s personal and discretionary expenses, but not all add-backs are legitimate or well-documented. If buyers take them at face value, they could end up underestimating or overestimating the company’s cash flow potential. For example, an owner may declare family car payments as business expenses or declare a one-off legal charge it could easily face repeatedly. Aggressive add-backs or ones with no proof destroy trust and can lead to a reduced multiple.
Critical add-backs to review in SDE include:
- Owner’s salary and personal benefits
- Non-recurring legal or professional fees
- Excessive travel or entertainment costs
- Family member wages not required going forward
- One-time repairs or upgrades
Buyers really need to check every adjustment, demand documentation and question anything that looks suspicious. This in turn means the business’s true earning power is transparent.
Ignoring Capital Needs
Buyers often view EBITDA as an indicator of operating performance and disregard what it takes to keep the business going or expanding. EBITDA does not account for cash going out to repay loans, corporation tax, VAT, or replacing and upgrading assets.
Key capital needs checklist:
- Asset replacement cycles – are equipment or vehicles coming up for renewal?
- Routine upgrades – does the business require IT, tools or machinery updates?
- Working capital will additional cash be required to support growth or seasonal fluctuations?
- Tax liabilities and servicing debt are there big tax bills or loan repayments looming?
- Maintenance costs—are facilities or equipment in good working order?
Overlooking these expenses can catch buyers unawares for future cash drains. Taking these requirements into consideration fosters a more robust and sustainable business model and keeps unwelcome surprises at bay post-sale.
Confusing Profit with Cash
Profit isn’t the same as cash flow, although SDE and EBITDA frequently concern profit-based figures. A business can appear highly profitable yet have poor cash flow if it experiences slow payments, significant stock requirements or large one-off costs.
Key differences:
- Profit contains uncollected revenue. Cashflow tracks money in.
- EBITDA misses cash outflows like tax and loan repayments
- One-off revenue spikes can make profits appear healthier than they really are.
Buyers need to see how stable cash flow is, not just declared profits. This shows whether the company can pay its bills, invest and ride out lean periods. A company with steady, repeatable EBITDA is more compelling as it demonstrates resilience greater than the figures.
Conclusion
SDE and EBITDA both provide a solid look at a business’s cash flow. SDE suits small businesses where the owner’s involvement dictates profit, whereas EBITDA is better for larger companies with stable staff. Both narrate a straightforward tale of cash in and out. Buyers can rely on these numbers to price fairly and identify risks. Compare both, understand what drives the figures, and ask the right questions. True transactions demonstrate that savvy purchasers get into the nitty gritty, not merely the totals. To get the most from your next deal, think of the two as tools, not rules. Got more questions or want examples in real life? Let me know your thoughts or get in touch for a longer chat.
Frequently Asked Questions
What is SDE?
What is SDE? It indicates the overall financial return one owner-operator would receive from the business, including owner salary, benefits, and profits, making it a strong valuation metric.
What is EBITDA?
EBITDA, a powerful valuation tool, stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, excluding non-operational costs to provide a strong valuation of a company’s operating performance.
How do SDE and EBITDA differ?
SDE business includes the owner’s salary and personal expenses, making it ideal for small business valuation. In contrast, EBITDA provides a clearer picture of core profitability, serving as a powerful valuation tool for larger companies.
Which should I use: SDE or EBITDA?
For small business valuation, utilize SDE when the owner is heavily involved, while larger firms should consider EBITDA multiples for accurate valuation.
How do these metrics affect business price?
We often see small business valuations being determined as a multiple of EBITDA or SDE business earnings, where strong EBITDA figures typically lead to a higher price.
Are SDE and EBITDA used globally?
EBITDA is a powerful valuation tool globally and in larger deals, while SDE business metrics are more prevalent in small business valuation, especially in North America.
What mistakes do first-time buyers make with these metrics?
Buyers often ignore SDE business or EBITDA adjustments, comparing the wrong valuation multiples for the size of the business. Read the small print to avoid paying more than necessary.
