What Is Seller’s Discretionary Earnings (SDE) — And Why It Matters When Selling Your Business
- Mark Hartmann
- 15 minutes ago
- 6 min read
If you’re a business owner thinking about retirement, one of the first questions you’re probably asking yourself is: What is my business worth?
That’s a great question—and one I help answer every day. But before we can talk about valuation, we have to understand the foundation of most small business valuations: Seller’s Discretionary Earnings, or SDE.
In this post, I’ll walk you through what SDE is, how it’s calculated, why it matters, and what it means for your exit strategy. Whether you’re a year away from selling or just starting to think about retirement, understanding your SDE is one of the smartest things you can do.
What Is Seller’s Discretionary Earnings (SDE)?
Seller's Discretionary Earnings measure a single owner-operator's total financial benefit from a business in a given year. It includes the company’s net profit plus certain add-backs representing perks or benefits the owner takes from the company.
Think of SDE as the money you, as the owner, could walk away with before taxes and after normalizing for non-recurring, discretionary, or non-operational expenses.
Why does this matter? SDE helps buyers understand how much money they could reasonably expect to make if they were in your shoes.
Why Buyers (and Brokers) Rely on SDE
For businesses in the $1 million to $5 million valuation range, buyers are often individuals, small private equity firms, or strategic acquirers who want to operate or oversee the business directly. In these cases, they care about how much income the company can generate for an owner.
Larger businesses ($5 million to $25 million and up) are often valued based on EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Still, SDE is the standard metric for most owner-operated businesses.
When I sold my own business, understanding SDE helped me paint a clear and compelling financial picture for potential buyers. Now, as an M&A advisor, I do the same for my clients.
What’s Included in SDE?
Let’s break it down. To calculate SDE, we start with the net income of the business (the bottom line on your income statement), then we add back the following items:
1. Owner’s Salary and Perks
Any salary, distributions, or personal expenses run through the business that wouldn’t be necessary for a new owner are added back. This includes:
• Your salary or guaranteed payments
• Health insurance premiums (if paid by the business)
• Retirement plan contributions
• Auto expenses
• Travel or meals not related to business operations
Buyers assume they'll compensate themselves however they see fit—so your compensation is added back.
2. Non-Cash Expenses
Expenses like depreciation and amortization are non-cash—they reduce your taxable income but don’t represent actual money out the door. These are added back to reflect true cash flow.
3. One-Time or Non-Recurring Expenses
Any unusual, one-off expenses that aren’t expected to happen again can be added back. Examples might include:
• Legal fees for a lawsuit that’s been resolved
• Major equipment repairs
• COVID-related costs
• One-time marketing campaigns
The key is to justify why a new owner won't repeat these.
4. Non-Business or Personal Expenses
It’s common for owners to run some personal expenses through the business. These are added back, too, but must be well-documented:
• Personal travel
• Family members on the payroll who don't actively work in the business
• Club memberships or entertainment expenses
Transparency is critical. We only add back what we can verify and justify to buyers during due diligence.
5. Interest and Taxes
Because different buyers finance deals differently and tax situations vary, interest and taxes are typically added back.
An Example SDE Calculation
Let’s say your business’s financials look like this:
ITEM | AMOUNT |
Net Income | $250,000 |
Owner's Salary | $150,000 |
Depreciation | $20,000 |
Amortization | $5,000 |
Owner's Health Insurance | $15,000 |
One-Time Legal Fee | $10,000 |
Personal Travel | $7,000 |
Interest Expense | $8,000 |
Taxes | $12,000 |
SDE = Net Income + Add-Backs
$250,000 + $150,000 + $20,000 + $5,000 + $15,000 + $10,000 + $7,000 + $8,000 + $12,000
= $477,000
In this example, a buyer could earn $477,000 from the business annually if they took over operations.
Why Getting SDE Right Is So Important
If your SDE is too low, your business may be undervalued. Buyers will lose trust if your SDE is inflated or filled with questionable add-backs—and your deal could fall apart during due diligence.
That’s why I spend so much time working with business owners to normalize financials and defend every add-back with solid documentation. We want your business to be presented in the best possible light—without overpromising or raising red flags.
SDE and Business Valuation
Once we have your SDE, we multiply it by a valuation multiple to estimate your business is worth. The multiple varies depending on several factors:
• Industry
• Size and scale of your company
• Growth trends
• Customer concentration
• Recurring revenue
• Competitive advantages
• Owner involvement
• Clean books
Most owner-operated businesses in the $1M–$5M range sell for 2.5x to 4.5x SDE. That means if your SDE is $500,000, your business could be worth anywhere from $1.25 million to $2.25 million.
For larger companies with stronger management teams and more scalable operations, the multiple might climb to 5x or more, and the valuation method may shift to EBITDA.
Common Mistakes Owners Make When Estimating SDE
1. Overestimating Add-Backs
Not every expense qualifies as an add-back. If it’s truly needed to run the business or would apply to a new owner, it’s not discretionary.
2. Mixing Personal and Business Expenses
Running personal expenses through the business can make it harder to obtain clean financials and can create doubt in a buyer's mind. If you're preparing to sell, it's time to start separating the two.
3. Not Keeping Records
You need to prove every add-back with documentation. That means clean books, clear notes, and tax returns that support the numbers.
How to Maximize Your SDE (and Business Value)
The best time to start preparing your business for sale is 1–2 years before you plan to exit. Here are some steps to boost your SDE:
• Clean up your books: Work with a CPA to ensure your financials are accurate, organized, and audit-ready.
• Reduce unnecessary expenses: Eliminate personal or non-essential spending.
• Document everything: Keep a detailed record of any add-backs you plan to include.
• Transition roles: Reduce your day-to-day involvement to make the business more attractive to buyers.
By proactively managing your financials and maximizing SDE, you increase the value of your business and make it easier to sell.
SDE vs. EBITDA: What’s the Difference?
Buyers might start looking at EBITDA instead of SDE if your business generates $1 million or more in earnings. So what’s the difference?
SDE includes:
• EBITDA
• Owner’s salary
• Owner’s perks and discretionary expenses
EBITDA includes:
• Earnings before interest, taxes, depreciation, and amortization (but not the owner's salary or perks)
EBITDA is more appropriate for businesses with multiple owners or a professional management team already in place. SDE is typically used for smaller, owner-operated companies.
Final Thoughts: Know Your Numbers Before You Sell
When I meet with a business owner for the first time, one of the first things I ask is, "Do you know your SDE?" It's a simple question with a significant impact.
SDE gives buyers the clarity they need to evaluate your business and gives you a powerful tool to defend your asking price. It also helps you understand how much you might walk away with after a sale, which is essential for retirement planning.
If you're considering selling your business in the next few years, now is the time to get your SDE in order. At HartmannRhodes, I help business owners like you maximize their company's value, avoid costly mistakes, and confidently exit.
You spent decades building your business. Now it’s time to transition on your terms—with expert guidance, a clear plan, and the best possible outcome.
Need Help Understanding Your SDE?
If you're curious about your business's worth or just want a second opinion on your numbers, reach out. I offer confidential, no-obligation consultations to help you take the first step toward a successful exit.
Blog: What Is Seller’s Discretionary Earnings (SDE) — And Why It Matters When Selling Your Business
Mark Hartmann is a former business owner turned M&A advisor who knows firsthand what it takes to build, grow, and sell a successful company. A three-time Inc. 5000 CEO, Mark did just that before navigating its eight-figure sale—giving him a rare perspective that sets him apart from most brokers. Today, he helps owners of companies valued between $1M and $25M plan and execute smooth, profitable exits.
Mark understands that selling a business isn’t just a financial decision—it’s personal. That’s why he works closely with owners to protect their legacy, maximize value, and make the transition on their terms. He holds an MBA from Eastern University, a Master’s Degree in Organizational Change Management from St. Elizabeth University, and a Graduate Certificate in Executive Coaching from Columbia University. Some of his professional credentials include Certified Mergers & Acquisitions Professional (CM&AP), Certified Business Intermediary (CBI), Certified Exit Planning Advisor (CEPA), and Certified Value Builder (CVB).
44 Washington Street, Unit #1080
Morristown, NJ 07960
Partner with HartmannRhodes, expert business brokers and M&A advisors, to navigate your business sale with precision—maximizing value and ensuring a smooth transition. Reach out for tailored business sale strategies. Contact us today!