⬢ Exit guide

How to Calculate SDE (Seller's Discretionary Earnings)

Before anyone can tell you what your business is worth, you need one number: your SDE. It's simpler than it sounds, and getting it right is the difference between a fair offer and a lowball.

How to Calculate SDE (Seller's Discretionary Earnings)

Imagine you have spent decades building your company. You have a loyal customer base, a dedicated team, and a business that runs smoothly. Now, as you look toward your next chapter, you ask the most critical question: "What is my business actually worth?"

When you look at your tax returns, the "bottom line" net profit rarely tells the whole story. For a small business owner, the tax return is designed to minimize taxable income, not to showcase the true earning power of the company. This is where Seller's Discretionary Earnings (SDE) comes into play. SDE represents the total financial benefit a single owner-operator derives from the business.

The SDE Formula

To find your SDE, you start with your net profit and "add back" expenses that a new owner might not incur or that are specific to your personal lifestyle. The calculation is as follows:

SDE = Net Profit + Owner's Salary + Owner's Personal/Discretionary Expenses + One-time Non-recurring Expenses + Interest/Depreciation/Amortization

Breaking Down the Add-Backs

To calculate this accurately, you must decompose your profit and loss statement into specific categories:

Owner's Compensation

This includes your base salary and any bonuses you paid yourself. Since a buyer will be the new owner, they will be the one receiving this income.

Personal and Discretionary Expenses

Many owners run personal expenses through the business for tax efficiency. This might include a company car, health insurance, or travel. These are "discretionary" because a new owner can choose to eliminate them to increase their own take-home pay.

One-Time Non-Recurring Expenses

If you paid for a one-time legal settlement, a major website redesign, or a specific piece of equipment that won't be a repeating annual cost, these are added back. They do not reflect the ongoing operational cost of the business.

Interest, Depreciation, and Amortization

These are non-cash expenses or financing costs that vary from buyer to buyer. Because the new owner will have their own financing terms and depreciation schedules, these are added back to show the raw earning power of the assets.

The Reality of Valuation

Once you have your SDE, you can begin to understand what is my business worth. On average, small businesses sell at roughly 2.7x SDE. However, the math is only as good as the data.

The most common valuation error is inflating SDE with add-backs that will not survive a buyer's due diligence. If you claim an expense is "one-time" but it actually occurs every two years, a sophisticated buyer will catch it. Overstating your SDE creates a gap between the asking price and the final sale price, which can jeopardize the entire deal.

Accurate calculations provide a foundation of trust. When your numbers are defensible, you move from a position of hope to a position of strength. If you are ready to evaluate your position, you can start the process of planning your exit.

• Start with net profit and add back owner salary and personal expenses.
• Include non-recurring costs and interest/depreciation/amortization.
• Avoid inflating SDE with add-backs that cannot be proven during due diligence.
• Use the 2.7x average multiplier as a general benchmark for small business valuation.