SDE vs EBITDA: the difference, and which one your business is valued on
Seller’s discretionary earnings and EBITDA count the same profit two ways, with two sets of multiples. Here is one set of statements worked into both.
The difference between SDE and EBITDA is the owner’s pay. Seller’s discretionary earnings, or SDE, adds the owner’s salary and personal expenses back to profit, while EBITDA deducts a market salary for a manager. Owner operated businesses in Canada are priced on SDE and larger companies on EBITDA, so an EBITDA multiple applied to SDE overstates the price.
Two ways of counting the same profit
The difference between SDE and EBITDA is the owner’s pay. Seller’s discretionary earnings counts it as part of what the business earns, and EBITDA deducts a market salary for whoever runs the business. Every business sale prices a stream of earnings, and these two answers give two numbers for the same business, each with its own set of multiples.
- SDE, seller’s discretionary earnings
- Profit before tax, plus interest, depreciation and amortisation, plus the owner’s salary and benefits, plus one off and personal expenses. It is everything one owner operator hands to the next, and it is also called adjusted earnings or owner’s cash flow.
- EBITDA
- Earnings before interest, taxes, depreciation and amortisation. It assumes someone is paid a market salary to run the business, so the owner’s pay stays out. It is the number a company with a management team is priced on.
For the same business, EBITDA is SDE less a market salary for whoever runs it.
Which one applies to you
If you run the business and take a salary or dividends from it, and a buyer would step into your role, you are priced on SDE. That covers most owner operated businesses in Canada below about $1 million of earnings.
If a management team runs it and the buyer will keep them, the buyer has to pay that team, and the business is priced on EBITDA. That is where private equity and larger strategic buyers look, and it is why the switch tends to happen around the point they arrive.
Many businesses sit on the line. A buyer who intends to run it will price on SDE, and a buyer who intends to hire a manager will price on EBITDA. The business is the same while the two numbers differ, and each buyer is right about their own case.
Why the multiples look so different
SDE is the bigger number, so the multiple applied to it is smaller. EBITDA is the smaller number, so its multiple is larger. A business priced at 3.5 times SDE and the same business priced at 5 times EBITDA can be the same price.
This is where owners get misled, and almost always in the expensive direction. Multiples published online mostly come from American companies far larger than an owner operated business, and they are mostly quoted against EBITDA. Applying one of them to your SDE produces a price above anything a buyer will pay.
The worked example
A business shows $320,000 of profit after paying its owner $180,000. A manager to replace the owner would cost $120,000.
| Measure | Amount |
|---|---|
| Profit on the statements | $320,000 |
| SDE: profit plus the owner’s $180,000 | $500,000 |
| EBITDA: SDE less a $120,000 manager | $380,000 |
| At 4 times SDE | $2,000,000 |
| At 4 times EBITDA | $1,520,000 |
| At 4 times profit, wrongly | $1,280,000 |
The last row is the common mistake. An owner who applies an SDE multiple to the profit on the statements, and leaves their own pay out of it, undervalues the business by about $700,000. Correcting that is the owner’s job, because the buyer gains from the error.
From one set of statements to both numbers
Take, as an illustration, a distribution company with $3 million of revenue. Its income statement shows $210,000 of profit before tax after paying the owner a $150,000 salary. The owner also runs a personal vehicle through the company at $12,000 a year, and last year paid a one time $8,000 legal bill for a dispute that is now settled.
| Line | Amount | Running total |
|---|---|---|
| Profit before tax, from the income statement | $210,000 | $210,000 |
| Add interest on the equipment loan | $18,000 | $228,000 |
| Add depreciation and amortisation | $42,000 | $270,000 |
| Add back the owner’s salary | $150,000 | $420,000 |
| Add the personal vehicle | $12,000 | $432,000 |
| Add the settled legal bill | $8,000 | $440,000 |
| SDE | $440,000 | |
| Deduct a market salary for a general manager | $110,000 | $330,000 |
| EBITDA, adjusted | $330,000 |
Manufacturing and distribution businesses sell for 3.0 to 5.5 times adjusted earnings on the industry table. At 3.5 times SDE this company is worth $1,540,000. A buyer pricing on EBITDA reaches the same $1,540,000 at about 4.7 times, which is why the larger multiple tells you little until you know what it multiplies.
The accountant’s EBITDA line on these statements would read $270,000, because it still deducts the owner’s actual $150,000 salary. Buyers adjust it by swapping in the $110,000 market salary and adding back the personal and one time costs, which brings it to $330,000.
The same mistake applies here. Multiplying the $210,000 of pre-tax profit by 3.5 gives $735,000, less than half the price this business supports. For that reason the AI Valuation tool adds back the costs that stay with the owner before it applies any multiple.
Add backs, and which ones a buyer accepts
Getting from the statements to SDE means adding back costs a new owner would leave behind. Buyers accept some readily and argue about others.
- Accepted readily. The owner’s salary and benefits are added back, and so are interest, depreciation and amortisation. So is a genuinely one time cost, such as a lawsuit that is over or a move that is done.
- Accepted with evidence. A vehicle, travel or phone that is really personal qualifies once the records show it. The same goes for a family member on the payroll in name only, and for rent above market paid to a company the owner also owns.
- Argued about. Buyers dispute repairs the owner calls one off that recur every year, and marketing the owner stopped doing. They also dispute anything labelled discretionary that a new owner would need to keep spending.
The rule buyers apply is simple: an add back has to be a cost that ends with your ownership. A cost the buyer would also carry stays in the expenses, whatever the statements call it. Preparing a business for sale covers how to document each add back before a buyer asks.
What to ask when someone quotes you a multiple
Ask which number it is multiplied by, and what size of business it comes from. An answer of EBITDA and a hundred million of revenue tells you the multiple belongs to a different kind of company. An answer of adjusted earnings and businesses like yours tells you it might apply to you. For a subscription software company the answer may be recurring revenue, a different basis again.
The ranges we price against are stated against SDE for owner operated Canadian businesses, which is why they sit below the numbers a competitor reprints. They are lower because the number they multiply is higher. How to value a business walks through the full method.
Questions owners ask
- What is the difference between SDE and EBITDA?
- SDE adds the owner’s salary and benefits back to profit, along with interest, depreciation and personal or one off costs. EBITDA makes the same additions and then deducts a market salary for a manager. SDE is the measure for owner operated businesses, and EBITDA is the measure for companies with a management team.
- What is SDE in a business sale?
- Seller’s discretionary earnings is the profit of the business plus the owner’s salary and benefits, plus one off and personal expenses that end with the current owner. It is the total cash one owner operator hands to the next.
- Is EBITDA or SDE higher?
- SDE is higher, because it includes the owner’s pay. For the same business, EBITDA is SDE less a market salary for whoever runs it. That is why EBITDA multiples look bigger: they are applied to a smaller number.
- What are add backs?
- Add backs are expenses on the books that stay with the departing owner, added back to profit to get to adjusted earnings. Common ones are the owner’s salary above a market rate, a vehicle or travel that is really personal, a one time legal bill, and family members on the payroll in name only.