One of the basic financial figures used in valuing businesses is this thing called EBITDA which stands for Earnings Before Interest, Taxes, Depreciation and Amortization. When it comes to valuing small businesses, however, you will often find that the value has really been based on something called SDE which is Seller’s Discretionary Earnings. So what’s the different between the two?
The International Business Brokers Association (IBBA) defines Discretionary Earnings as the earnings of a business enterprise prior to the following items:
- Income Taxes (EBITDA item)
- Non-operating Income and Expenses
- Nonrecurring Income and Expenses
- Depreciation and Amortization (EBITDA item)
- Interest Expense or Income (EBITDA item)
- Owner’s Total Compensation for those services that could be provided by a sole owner/manager.
As a general rule, the Non-operating and Nonrecurring Income and Expenses would be adjusted out whether the basis for the valuation is EBITDA or SDE. Based on the above, you can see that SDE can also be calculated as EBITDA+Owner’s Total Compensation.
When is SDE used instead of EBITDA? Generally when a business has a hands-on owner-operator or is the type of business which is typically owner-operated, SDE is used. When the business is typically investor owned or is management run, EBITDA is used.