EBITDA and SDE are two different ways of measuring the earnings, or income generating ability, of a business. EBITDA is Earnings, Before deducting for Interest, Taxes on income, Depreciation, and Amortization. SDE, or Seller’s Discretionary Earnings, is EBITDA plus deducting for all of the owner’s income and benefits. In calculating EBITDA and SDE, for purposes of pricing a business for purchase, one-time, non-recurring income and expenses should be removed and any income or expense not related to the business being sold should be removed. In both, normal expense for equipment replacement should be included.
Should EBITDA or SDE be used when pricing a business? Of course, both could be used. The multiple that is applied, depending on which measure is used, should be different. It would not be an accurate valuation to calculate EBITDA, which is normally much less than SDE, and use the multiples used with SDE. This would result in a low price.
The more important basis on which to choose between EBITDA or SDE is the nature of the business and the owner’s role in it. It is said that the small business owner is “buying a job”. This is because in the typical purchase of a small business, the owner is also the active general manager of the business. In this situation, the buyer is looking at all of the money available to the owner to live on, pay back any loans, working capital needs, and return on investment. The amount needed to live on is usually a large percentage of the SDE.
In a larger business, where the owner is not the general manager, the owner is looking at the business as an investment. A good measure of the return on the investment is EBITDA.
In the sale of most small businesses, the market price is based on SDE because most buyers will be owner operators. In many of these sales, the business does not generate enough money to hire a general manager and still generate an income satisfactory to an absentee owner. Another reason that buyers are owner-operators is because that is what they are comfortable doing.
If you are buying a business, know the difference between EBITDA and SDE and which measure is the best one to use when pricing a business that you are thinking of buying.
