SDE vs. EBITDA: Which Metric Should You Use for Business Valuation?

Which is better for valuing a business: SDE or EBITDA? It depends on the business size, structure, and buyer type.

Key Takeaway

For small businesses, SDE reflects the total cash flow available to an owner-operator. For larger businesses, EBITDA highlights core operational performance. Choose the metric that aligns with your business type and acquisition goals.

SDE vs. EBITDA: Main Differences

What Each Metric Includes

SDE (Seller's Discretionary Earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) measure financial performance, but they focus on different aspects of a business. SDE highlights available cash flow by adding back the owner’s salary and personal expenses, while EBITDA reflects operational performance, excluding owner-related expenses.

Here’s a simple example: Imagine a business with an annual net income of $68,000. The owner takes a $60,000 salary and charges $200 in personal expenses. For SDE, you’d add back the salary and personal expenses, showing a higher cash flow. On the other hand, EBITDA treats the owner’s salary as a standard business expense, so it wouldn’t include those adjustments.

Here’s a breakdown of what each metric includes:

‍
Component
SDE
EBITDA

Included
Included

Added back
Added back

Added back
Added back

Added back
Added back

Added back
Added back

Added back
Not included

Added back
Not included

Added back
Selective inclusion

By understanding these components, you can decide which metric best suits your valuation needs.

When to Use Each Metric

Choosing between SDE and EBITDA depends on the size of the business, its structure, and the type of buyer. Here’s how to decide:

SDE is ideal for:

EBITDA works best for:

Using the wrong metric can lead to skewed valuations. For instance, a business with $500,000 in net profit and $200,000 in owner compensation would show an SDE of $700,000, but its EBITDA would remain $500,000. With typical valuation multiples - 3× for SDE and 5× for EBITDA - this could create a $400,000 difference in the valuation.

Smaller businesses valued with SDE often see multiples of 2–3 times earnings, while larger companies using EBITDA can command multiples ranging from 4–8 times earnings or more.

Kumo’s database and analytics tools simplify this process, allowing buyers to filter and compare businesses based on their preferred metric.

SDE vs EBITDA, when to use one vs the other. How to calculate it and chose the appropriate multiple

Calculation Methods

Getting the numbers right for SDE (Seller’s Discretionary Earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is key to consistent valuations for small and medium-sized businesses.

How to Calculate SDE

To calculate SDE, you start with net income and add back expenses that are owner-related or not tied to regular operations. Here’s the formula:

SDE = Net Income + Interest + Taxes + Depreciation + Amortization + Owner's Compensation + Owner's Benefits + Non-recurring Expenses + Personal Expenses

Let’s break it down with an example. Business A has the following financial data:

Component
Amount

Net Income
$68,000

Interest Income
$25

Interest Expense
$435

Taxes
$14,280

Depreciation
$2,150

Amortization
$300

Non-recurring Expenses
$67

Owner's Compensation
$60,000

Personal Expenses
$200

When working out SDE, you need to pinpoint all the expenses that can be added back, such as owner's compensation, owner's benefits, non-recurring expenses, and personal expenses.

These adjustments ensure that the SDE reflects the true earning potential of the business for a prospective buyer.

How to Calculate EBITDA

EBITDA zeroes in on operational performance, excluding the influence of financing and non-cash expenses. The formula is straightforward:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

For larger businesses, adjusted EBITDA is often used to provide a clearer picture of normalized profitability. Here’s an example for a mid-sized business:

‍
Component
Amount

Net Income
$500,000

Interest
$50,000

Taxes
$100,000

Depreciation
$80,000

Amortization
$20,000

To calculate adjusted EBITDA, you also include normalizing adjustments like:

To avoid mistakes, double-check that no expenses are counted twice, document every adjustment, and clearly separate recurring items from non-recurring ones.

If you’re looking for a way to simplify this process, tools like Kumo's analytics can be a game-changer. They can automatically identify potential add-backs and normalization adjustments, ensuring that the right metrics are applied consistently across different businesses, no matter their size or type.

Selecting the Best Metric

Choosing the right metric for valuation depends heavily on the business structure and acquisition goals. Let’s break down how these factors influence the decision-making process.

Business Structure and Deal Type

The type of business plays a major role in determining which profitability metric to use. For instance, Baton Market highlights that Seller’s Discretionary Earnings (SDE) is applied in over 90% of small business transactions valued under $5 million. SDE works best for owner-operated businesses, where the owner’s compensation and discretionary expenses are significant. On the other hand, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is more suitable for management-run or larger companies.

Here’s a quick breakdown of how business characteristics align with these metrics:

Business Characteristic
Recommended Metric
Key Considerations

Owner-Operated (< $5M)
SDE
Includes owner's salary and discretionary costs

Management-Run/Larger (> $5M)
EBITDA
Focuses on core operating performance

This distinction ensures that valuation approaches are tailored to the specific operational setup of the business. The structure of the company and the buyer’s intentions work together to determine the appropriate metric.

Buyer Types and Goals

The goals and type of buyer also play a critical role in selecting the right metric. Individual buyers, who often step into an owner-operator role, prioritize SDE because it reflects the total cash flow they could personally benefit from. In contrast, institutional investors or strategic buyers lean toward EBITDA as it provides a clearer picture of the company’s core operational performance.

Here’s how to decide:

Kumo’s analytics tools make this process even easier. Buyers can filter opportunities based on their preferred metric, and data from the platform shows that businesses listed with the correct metrics attract more qualified inquiries and close deals faster.

Using Tech Tools for Metric Analysis

With the groundwork laid through detailed SDE and EBITDA calculations, advanced tech tools now offer a faster, smarter way to analyze and monitor metrics in real time. These tools are becoming essential for modern deal analysis, helping users evaluate SDE and EBITDA with greater efficiency and accuracy.

Data Analysis Tools

Today's platforms simplify the process of normalizing and comparing financial metrics across multiple business listings. For example, Kumo's platform processes large volumes of financial data, providing buyers with valuable features:

Ensures consistent SDE and EBITDA calculations across various listings

Tracks changes in financial metrics over time

Breaks down complex data into straightforward insights

Allows users to analyze data in their preferred spreadsheet tools

The platform’s AI-driven tools quickly highlight trends and anomalies, making it easier to determine if a business's reported SDE or EBITDA aligns with industry norms. This automation replaces time-consuming manual reviews, letting users focus on evaluating opportunities. Beyond data analysis, enhanced search functions further refine the process.

Search and Alert Features

In addition to normalizing metrics, smart search tools help buyers zero in on the most promising opportunities. Kumo's platform offers advanced filtering options to streamline the search for businesses that meet specific criteria.

"Make informed decisions with thoughtful, real-time insights into available deals. Then make your next move feeling confident in your data." - Kumo

Key features of the platform's search capabilities include:

These custom filters and alerts ensure buyers can quickly identify opportunities that align with their investment goals. By monitoring metrics in real time, the platform helps buyers act promptly on potential acquisitions.

The combination of robust data analysis tools and smart search features empowers buyers to make well-informed decisions. This streamlined approach significantly cuts down the time needed to identify and evaluate businesses based on profitability metrics.

Conclusion

For businesses with an SDE exceeding $100,000, valuations typically fall within 2–3× multiples. Deciding between SDE and EBITDA hinges on the business type and the buyer's goals. Smaller, owner-operated businesses often rely on SDE since it accounts for owner compensation and discretionary expenses, providing a clearer view of cash flow.

Advances in AI-powered tools are transforming how these metrics are analyzed. Platforms like Kumo bring this shift to life by offering AI-driven analytics that normalize SDE and EBITDA across listings. This makes the evaluation process faster and more efficient:

Side-by-side view of SDE and EBITDA across listings

Compare metrics against sector norms

Keep tabs on financial performance changes

Zero in on businesses that meet specific profitability criteria

These tools give buyers the ability to tailor valuation metrics to fit their specific deal requirements.

As the acquisition landscape evolves, using the right metric for the situation and leveraging modern tech tools can make all the difference. Whether SDE suits a small, owner-led venture or EBITDA fits a larger, management-driven company, aligning the metric with your objectives is key to a successful deal.

FAQs

Should I use SDE or EBITDA to value my business with fluctuating revenues around $5 million?

Choosing between SDE (Seller’s Discretionary Earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) largely depends on the size of your business and the purpose of the valuation.

SDE is typically used for smaller businesses, especially those generating less than $5 million in revenue. It highlights the owner’s total benefits and is easier to adjust for discretionary expenses, making it a practical choice for this segment. On the flip side, EBITDA is often preferred for larger businesses or those with steady revenue streams. It provides a clearer view of operational performance by excluding owner-specific adjustments, which is appealing to institutional buyers or investors.

If your business has fluctuating revenues around $5 million, it’s worth considering your target audience. Buyers interested in smaller businesses may lean toward SDE, while larger investors or institutional buyers are likely to focus on EBITDA. Platforms like Kumo can simplify the process of finding potential buyers or deals by helping you analyze and connect efficiently.

What mistakes should I avoid when calculating SDE and EBITDA for valuing a business?

When calculating SDE (Seller's Discretionary Earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization), there are a few mistakes you’ll want to steer clear of to ensure accuracy:

Avoiding these common errors will help you arrive at a financial assessment that is both accurate and dependable.

How can technology improve the accuracy and efficiency of using SDE and EBITDA in business valuations?

Technology tools play a crucial role in improving how SDE (Seller's Discretionary Earnings) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) are analyzed during business valuations. By automating tasks like data collection and calculations, these tools minimize the chances of manual errors while saving a significant amount of time.

Many advanced platforms go a step further by offering features such as data analytics, AI-driven insights, and customized reporting. These capabilities make it easier to spot trends, compare key metrics, and make well-informed decisions. This is particularly valuable when analyzing SMB deals, where both accuracy and speed are essential for evaluating opportunities effectively.

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